On Loss Aversion, Level-1 Reasoning, and Betting
AbstractPrevious research suggests that human reaction to risky opportunities reflects two contradicting biases: Òloss aversion", and Òlimited level of reasoning" that leads to overconfidence. Rejection of attractive gambles is explained by loss aversion, while counterproductive risk seeking is attributed to limited level of reasoning. The current research highlights a shortcoming of this popular (but often implicit) "contradicting biases" assertion. Studies of "negative-sum betting games" reveal high rate of counterproductive betting even when limited level of reasoning and loss aversion imply no betting. The results reflect two reasons for the high betting rate: initial tendency to participate and slow learning. Under certain conditions, the observed betting rate was higher than the rate predicted under random choice even after 250 trials with immediate feedback. These results can be captured with a model that assumes a tendency to select strategies that have led to good outcomes in a small set of similar past experiences, and allows for an initial framing effect.
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Bibliographic InfoPaper provided by Department of Management, Università Ca' Foscari Venezia in its series Working Papers with number 2.
Length: 30 pages
Date of creation: Apr 2013
Date of revision:
Loss aversion; Level-1 reasoning; SamuelsonÕs Colleague; acquiring a company problem; market for lemons;
Find related papers by JEL classification:
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
- D03 - Microeconomics - - General - - - Behavioral Economics; Underlying Principles
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-05-11 (All new papers)
- NEP-CBE-2013-05-11 (Cognitive & Behavioural Economics)
- NEP-EXP-2013-05-11 (Experimental Economics)
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