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The prospect of a perfect ending: Loss aversion and the round-number bias

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  • Fraser-Mackenzie, P.
  • Sung, M.
  • Johnson, J.E.V.

Abstract

Studies across a range of domains have shown that individuals tend to focus on round numbers as cognitive reference points; a so-called left-digit effect. We explain this effect by combining analog numerical heuristics with prospect theory in order to develop an analog value function that predicts the key characteristics of the left-digit effect. Most importantly, this value function predicts an unreported phenomenon, namely; that the left-digit effect will be more pronounced in situations involving losses (cf. gains). We confirm this prediction in both a laboratory experiment regarding hypothetical investments and analysis of buy–sell imbalances in over 15million trades by investors in a financial market. We conclude that our analog value function is a promising explanation for the left-digit effect. Furthermore, we suggest that interventions aimed at reducing costly buy–sell imbalances in financial markets should focus on the decisions made by investors when they are facing loss.

Suggested Citation

  • Fraser-Mackenzie, P. & Sung, M. & Johnson, J.E.V., 2015. "The prospect of a perfect ending: Loss aversion and the round-number bias," Organizational Behavior and Human Decision Processes, Elsevier, vol. 131(C), pages 67-80.
    • Handle: RePEc:eee:jobhdp:v:131:y:2015:i:c:p:67-80
    DOI: 10.1016/j.obhdp.2015.08.004
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    Cited by:

    1. Chen, Tao, 2018. "Round-number biases and informed trading in global markets," Journal of Business Research, Elsevier, vol. 92(C), pages 105-117.
    2. John List, 2021. "How Field Experiments in Economics Can Complement Psychological Research on Judgment Biases," Natural Field Experiments 00738, The Field Experiments Website.
    3. Stephen L. Ross & Tingyu Zhou, 2020. "Documenting Loss Aversion using Evidence of Round Number Bias," Working papers 2020-17, University of Connecticut, Department of Economics.
    4. Matteo Migheli, 2017. "The winner’s curse in auctions with losses," Mind & Society: Cognitive Studies in Economics and Social Sciences, Springer;Fondazione Rosselli, vol. 16(1), pages 113-126, November.
    5. Kimbrough, Erik O. & Porter, David & Schneider, Mark, 2021. "Reference dependent prices in bargaining: An experimental examination of precise first offers," Journal of Economic Psychology, Elsevier, vol. 86(C).
    6. Stephen L. Ross & Tingyu Zhou, 2020. "Documenting Loss Aversion Using Evidence of Round Number Bias," Working Papers 2020-079, Human Capital and Economic Opportunity Working Group.
    7. Haim Levy & Moshe Levy, 2021. "Prospect theory, constant relative risk aversion, and the investment horizon," PLOS ONE, Public Library of Science, vol. 16(4), pages 1-21, April.

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