On loss aversion, level-1 reasoning, and betting

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 t...

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Bibliographic Details
Published in:International journal of game theory 2015, Vol.44 (1), p.113-133
Main Authors: Erev, Ido, Gilat-Yihyie, Sharon, Marchiori, Davide, Sonsino, Doron
Format: Article
Language:English
Subjects:
Analysis
Behavior
Behavioral/Experimental Economics
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Economics and Finance
Expected values
Feedback
Gambling
Game Theory
Hypotheses
Market entry
Operations Research/Decision Theory
Securities markets
Social and Behav. Sciences
Studies
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Summary: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.
ISSN:0020-7276
1432-1270
DOI:10.1007/s00182-014-0421-2