Hyperopic Loss Aversion
36 Pages Posted: 20 May 2020
Date Written: April 21, 2020
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: Suggested Citation