Hyperopic Loss Aversion

36 Pages Posted: 20 May 2020

See all articles by Jan Krause

Jan Krause

Kiel Institute for the World Economy

Patrick Ring

Kiel Institute for the World Economy

Ulrich Schmidt

Kiel Institute for the World Economy

Date Written: April 21, 2020

Abstract

The literature reports a tendency that future losses are discounted less than future gains, the so-called sign effect in intertemporal decision making. In this article, we study implications of the sign effect on risk taking: If future losses are discounted less than future gains, mixed lotteries involving both gains and losses should become less attractive when payments are delayed into the future. We refer to this phenomenon as Hyperopic Loss Aversion and provide experimental evidence for it: First, we provide a robust conceptual replication of the sign effect where we find non-positive discount rates for losses. Second, we confirm our hypothesis that mixed lotteries become less attractive over time. This effect can be attributed to Hyperopic Loss Aversion in our design, as a delay does not change the valuation of either pure gain and pure loss lotteries. Finally, we apply the notion of Hyperopic Loss Aversion to investment decisions and show that it offers a novel behavioral explanation for the equity premium puzzle. While our empirical analyses are entirely model-free, we also introduce a theoretical basis to analyze Hyperopic Loss Aversion. Our model, termed Discounted Prospect Theory, can be regarded as a natural extension of Prospect Theory to the intertemporal domain.

Keywords: Discounting, Loss Aversion, Equity Premium Puzzle, Experiments, Time, Gains, Losses, Real Incentives, Hypothetical Incentives, Hyperopia

JEL Classification: D01, D90, D91, G11, G40, G41

Suggested Citation

Krause, Jan and Ring, Patrick and Schmidt, Ulrich, Hyperopic Loss Aversion (April 21, 2020). Available at SSRN: https://ssrn.com/abstract=3582050 or http://dx.doi.org/10.2139/ssrn.3582050

Jan Krause

Kiel Institute for the World Economy ( email )

P.O. Box 4309
Kiel, Schleswig-Hosltein D-24100
Germany

Patrick Ring (Contact Author)

Kiel Institute for the World Economy ( email )

Kiellinie 66
Kiel, Schleswig-Holstein 24105
Germany

Ulrich Schmidt

Kiel Institute for the World Economy ( email )

P.O. Box 4309
Kiel, Schleswig-Hosltein D-24100
Germany

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