On Loss Aversion, Level-1 Reasoning, and Betting

30 Pages Posted: 13 Sep 2013

See all articles by Ido Erev

Ido Erev

Technion-Israel Institute of Technology - William Davidson Faculty of Industrial Engineering & Management

Sharon Gilat-Yihyie

Western Galilee College

Davide Marchiori

Ca Foscari University of Venice

Doron Sonsino

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management

Date Written: April 1, 2013

Abstract

Previous research suggests that human reaction to risky opportunities reflects two contradicting biases: "loss aversion", and "limited 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.

Keywords: Loss aversion, Level-1 reasoning, Samuelson’s Colleague, acquiring a company problem, market for lemons

JEL Classification: C63, C73, D03, D82, D83

Suggested Citation

Erev, Ido and Gilat-Yihyie, Sharon and Marchiori, Davide and Sonsino, Doron, On Loss Aversion, Level-1 Reasoning, and Betting (April 1, 2013). Department of Management, Università Ca' Foscari Venezia Working Paper No. 2/2013. Available at SSRN: https://ssrn.com/abstract=2322446 or http://dx.doi.org/10.2139/ssrn.2322446

Ido Erev (Contact Author)

Technion-Israel Institute of Technology - William Davidson Faculty of Industrial Engineering & Management ( email )

Haifa 32000
Israel

Sharon Gilat-Yihyie

Western Galilee College ( email )

P.O. Box 2125
Acre, North 24121
Israel

Davide Marchiori

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venezia, 30123
Italy

Doron Sonsino

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management ( email )

Haifa 32000
Israel
(972) 4-8294435 (Phone)

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