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A psychological law of inertia and the illusion of loss aversion

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  • David Gal
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    Abstract

    The principle of loss aversion is thought to explain a wide range of anomalous phenomena involving tradeoffs between losses and gains. In this article, I show that the anomalies loss aversion was introduced to explain --- the risky bet premium, the endowment effect, and the status-quo bias --- are characterized not only by a loss/gain tradeoff, but by a tradeoff between the status-quo and change; and, that a propensity towards the status-quo in the latter tradeoff is sufficient to explain these phenomena. Moreover, I show that two basic psychological principles --- (1) that motives drive behavior; and (2) that preferences tend to be fuzzy and ill-defined --- imply the existence of a robust and fundamental propensity of this sort. Thus, a loss aversion principle is rendered superfluous to an account of the phenomena it was

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    Bibliographic Info

    Article provided by Society for Judgment and Decision Making in its journal Judgment and Decision Making.

    Volume (Year): 1 (2006)
    Issue (Month): (July)
    Pages: 23-32

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    Handle: RePEc:jdm:journl:v:1:y:2006:i::p:23-32

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    Related research

    Keywords: inertia; loss aversion; endowment effect; status-quo bias; risky choice; reference-dependent preferences;

    References

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    1. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    2. Strahilevitz, Michal A & Loewenstein, George, 1998. " The Effect of Ownership History on the Valuation of Objects," Journal of Consumer Research, University of Chicago Press, vol. 25(3), pages 276-89, December.
    3. Dhar, Ravi, 1997. " Consumer Preference for a No-Choice Option," Journal of Consumer Research, University of Chicago Press, vol. 24(2), pages 215-31, September.
    4. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, vol. 53(5), pages 1775-1798, October.
    5. Dubourg, W R & Jones-Lee, M W & Loomes, Graham, 1994. "Imprecise Preferences and the WTP-WTA Disparity," Journal of Risk and Uncertainty, Springer, vol. 9(2), pages 115-33, October.
    6. Bettman, James R & Luce, Mary Frances & Payne, John W, 1998. " Constructive Consumer Choice Processes," Journal of Consumer Research, University of Chicago Press, vol. 25(3), pages 187-217, December.
    7. Eugene Fama & F. & Kenneth R. French, . "The Equity Premium."," CRSP working papers 522, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    8. Tversky, Amos & Kahneman, Daniel, 1991. "Loss Aversion in Riskless Choice: A Reference-Dependent Model," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1039-61, November.
    9. Samuelson, William & Zeckhauser, Richard, 1988. " Status Quo Bias in Decision Making," Journal of Risk and Uncertainty, Springer, vol. 1(1), pages 7-59, March.
    10. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
    11. Daniel S. Putler, 1992. "Incorporating Reference Price Effects into a Theory of Consumer Choice," Marketing Science, INFORMS, vol. 11(3), pages 287-309.
    12. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1325-48, December.
    13. Thaler, Richard, 1980. "Toward a positive theory of consumer choice," Journal of Economic Behavior & Organization, Elsevier, vol. 1(1), pages 39-60, March.
    14. David R. Bell & James M. Lattin, 2000. "Looking for Loss Aversion in Scanner Panel Data: The Confounding Effect of Price Response Heterogeneity," Marketing Science, INFORMS, vol. 19(2), pages 185-200, May.
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    Cited by:
    1. Kenneth Gillingham & Karen Palmer, 2014. "Bridging the Energy Efficiency Gap: Policy Insights from Economic Theory and Empirical Evidence," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 8(1), pages 18-38, January.
    2. Konstantinos V. Katsikopoulos & Cherng-Horng (Dan) Lan, 2011. "Herbert Simon’s spell on judgment and decision making," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 6(8), pages 722-732, December.
    3. Malul, Miki & Rosenboim, Mosi & Shavit, Tal, 2013. "So when are you loss averse? Testing the S-shaped function in pricing and allocation tasks," Journal of Economic Psychology, Elsevier, vol. 39(C), pages 101-112.
    4. Greene, David L., 2011. "Uncertainty, loss aversion, and markets for energy efficiency," Energy Economics, Elsevier, vol. 33(4), pages 608-616, July.

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