The Origin of "Loss Aversion"

I am loss averse. I once almost went crazy looking for a wallet that I thought I had lost. As I ransacked the closets, checking every pocket, I got increasingly anxious. Thoughts of the money in the wallet, the credit cards, driver’s license, and social security card kept flashing through my mind. Whoever found the wallet could steal my identity, run up huge expenses, and put me in financial jeopardy!

My heart was pounding. I managed to go to work that morning, but I was distracted and couldn’t concentrate. I checked the store where I had shopped the day before. No wallet. I called the credit card companies and canceled my cards. I realized I was driving without a license, so I took time off from work to go to the registry to get a new one. I had pain in my chest.

That night, I couldn’t sleep. The pain wouldn’t go away, and at about 2:00 in the morning, I woke up my wife and asked her to drive me to the hospital. I thought I was having a heart attack. After a couple of hours of tests, X-rays, and an electrocardiogram, I was released. My heart was fine; it was just an anxiety attack. Really? Losing my wallet wasn’t that big a deal. I just had to cancel the cards, get a new license, and buy a new wallet. I lost a few bucks, but so what? And yet, I had been plagued with worry.

Frankly, we are all loss averse. People are generally more afraid of losing than they are eager to gain, a phenomenon dubbed "loss aversion" by Nobel laureate Daniel Kahneman and his collaborator Amos Tversky (1979, 1992).

How we evaluate potential gains and losses

In a typical study, when people are asked if they would rather get $500 for sure or a lottery ticket with a 50-50 chance to win $1000, they generally choose the sure thing. But when asked if they would rather lose $500 for sure or get a lottery ticket that offers a 50 percent chance of losing $1000, most choose to take the risk. The odds are the same, in both cases. It seems that people will take risks to avoid a loss that they would not take to get a benefit.

Why do people behave this way? We think that the mental mechanism evaluating potential gains and losses evolved long before the invention of money and was designed by evolution to evaluate the probability of harm, injury, and death.

Consider a Pleistocene hunter, on foot and armed with a spear, who is tracking a dangerous animal, say a bison or a wooly mammoth. It’s easy to understand why such a hunter would do everything possible to avoid harm to himself (a sure loss). He would be particularly vigilant, knowing if he were injured or killed, that his wife, children, and indeed his entire band would suffer. This, we suggest, is the origin of what has become known as loss aversion.

Why, then, would a hunter in his right mind ever risk harm to self? Because the hunter has to balance the possibility of personal physical harm, or even death, with the possibility of loss to him, his immediate family, and his band. Why does an Inuit hunter stand motionless beside a seal breathing hole for hours in the dead of winter, risking frostbite or worse? Because if he doesn’t bring meat back to the camp he and his family could starve. So, he takes a risk to avoid a sure loss.

Loss aversion in a modern context

In the modern loss aversion studies, there is no danger of injury or death, no starving family; there is only loss of money. But the emotions associated with loss, formed eons ago when loss was always frightening and often damaging to self and others, are with us still. The people who are the subjects in contemporary studies of aversion to losing money are using an ancient mechanism to respond to a new situation.

And, indeed, I think that’s why I blew the simple loss of a wallet way out of proportion.