International Journal of Game Theory

, Volume 44, Issue 1, pp 113–133

On loss aversion, level-1 reasoning, and betting

  • Ido Erev
  • Sharon Gilat-Yihyie
  • Davide Marchiori
  • Doron Sonsino
Article

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 

References

  1. Ball SB, Bazerman MH, Carroll JS (1991) An evaluation of learning in the bilateral winner’s curse. Organ Behav Hum Decis Process 48:1–22CrossRefGoogle Scholar
  2. Benartzi S, Thaler RH (1995) Myopic loss aversion and the equity premium puzzle. Quart J Econ 110:73–92CrossRefGoogle Scholar
  3. Bereby-Meyer Y, Grosskopf B (2008) Overcoming the winner’s curse: an adaptive learning perspective. J Behav Decis Mak 21:15–27CrossRefGoogle Scholar
  4. Camerer CF, Ho TH, Chong JK (2004) A cognitive hierarchy model of games. Q J Econ 119:861–898CrossRefGoogle Scholar
  5. Carroll JS, Bazerman MH, Maury R (1988) Negotiation cognition: a descriptive approach to negotiators’ understanding of their opponents. Organ Behav Hum Decis Process 41:352–370CrossRefGoogle Scholar
  6. Costa-Gomes M, Crawford VP, Broseta B (2001) Cognition and behavior in normal-form games: an experimental study. Econometrica 69:1193–1235CrossRefGoogle Scholar
  7. Erev I, Ert E, Roth AE (2010a) A choice prediction competition for market entry games: an introduction. Games 1:117–136CrossRefGoogle Scholar
  8. Erev I, Ert E, Roth AE, Haruvy H, Herzog SM, Hau R, Hertwig R, Stewart T, West R, Lebiere C (2010b) A choice prediction competition: choices from experience and from description. J Behav Decis Mak 23:15–47CrossRefGoogle Scholar
  9. Erev I, Haruvy H (in press) Learning and the economics of small decisions. In: Kagel JH, Roth AE (Eds) The handbook of experimental economics. Princeton University Press, PrincetonGoogle Scholar
  10. Ert E, Erev I (2008) The rejection of attractive gambles, loss aversion, and the lemon avoidance heuristic. J Econ Psychol 29:715–723CrossRefGoogle Scholar
  11. Fischbacher U (2007) z-Tree: Zurich toolbox for ready-made economic experiments. Exp Econ 10:171–178CrossRefGoogle Scholar
  12. Fox CR, Tversky A (1998) A belief-based account of decision under uncertainty. Manag Sci 44:879–895CrossRefGoogle Scholar
  13. Gilboa I, Schmeidler D (1995) Case-based decision theory. Q J Econ 110:605–639CrossRefGoogle Scholar
  14. Grosskopf B, Bereby-Meyer Y, Bazerman MH (2007) On the robustness of the winner’s curse phenomenon. Theory Decis 63:389–418CrossRefGoogle Scholar
  15. Johnson EJ, Goldstein D (2003) Do defaults save lives? Science 302:1338–1339CrossRefGoogle Scholar
  16. Kahneman D, Tversky A (1979) Prospect theory: an analysis of decision under risk. Econometrica 47:263–291CrossRefGoogle Scholar
  17. Knetsch JL, Sinden JA (1984) Willingness to pay and compensation demanded: experimental evidence of an unexpected disparity in measures of value. Q J Econ 99:507–521CrossRefGoogle Scholar
  18. Milgrom P, Stokey N (1982) Information, trade and common knowledge. J Econ Theory 26:17–27CrossRefGoogle Scholar
  19. Nagel R (1995) Unraveling in guessing games: an experimental study. Am Econ Rev 85:1313–1326Google Scholar
  20. Odean T (1999) Do investors trade too much? Am Econ Rev 89:1279–1298CrossRefGoogle Scholar
  21. Osborne MJ, Rubinstein A (1998) Games with procedurally rational players. Am Econ Rev 88:834–847Google Scholar
  22. Perets H, Sonsino D (1999) On preplay negotiations and zero-sum betting. Int Game Theor Rev 1:192–196CrossRefGoogle Scholar
  23. Redelmeier DA, Tversky A (1992) On the framing of multiple prospects. Psychol Sci 3:191–193CrossRefGoogle Scholar
  24. Rogers BW, Palfrey TR, Camerer CF (2009) Heterogeneous quantal response equilibrium and cognitive hierarchies. J Econ Theory 144:1440–1467CrossRefGoogle Scholar
  25. Roth AE, Erev I (1995) Learning in extensive form games: experimental data and simple dynamic models in the intermediate term. Games Econ Behav 8:164–212CrossRefGoogle Scholar
  26. Samuelson PA (1963) Risk and uncertainty: a fallacy of large numbers. Scientia 98:108–113Google Scholar
  27. Samuelson W, Bazerman MH (1985) Negotiation under the winner’s curse. In: Smith VL (ed) Research in experimental economics. Jai Press, Greenwich, pp 105–137Google Scholar
  28. Samuelson W, Zeckhauser R (1988) Status quo bias in decision making. J Risk Uncertain 1:7–59CrossRefGoogle Scholar
  29. Sebenius JK, Geanakoplos J (1983) Don’t bet on it: contingent agreements with asymmetric information. J Am Stat Assoc 78:424–426CrossRefGoogle Scholar
  30. Selten R, Chmura T (2008) Stationary concepts for experimental \(2 \times 2\) games. Am Econ Rev 98:938–966CrossRefGoogle Scholar
  31. Shefrin H, Statman M (1985) The disposition to sell winners too early and ride losers too long: theory and evidence. J Finance 40:777–790CrossRefGoogle Scholar
  32. Sonsino D, Erev I, Gilat S (2001) On rationality, learning and zero-sum betting: an experimental study of the no-betting conjecture. Working Paper, http://ie.technion.ac.il/Home/Users/erev/Sonsino_Erev_Gilat_2001.pdf. Accessed 30 March 2014
  33. Sonsino D (1995) “Impossibility of speculation” theorems with noisy information. Games Econ Behav 8:406–423CrossRefGoogle Scholar
  34. Sonsino D (1998) Sebenius and geanakoplos model with noise. Int J Game Theory 27:111–130CrossRefGoogle Scholar
  35. Søvik Y (2009) Strength of dominance and depths of reasoning: an experimental study. J Econ Behav Organ 70:196–205CrossRefGoogle Scholar
  36. Stahl DO (1996) Boundedly rational rule learning in a guessing game. Games Econ Behav 16:303–330CrossRefGoogle Scholar
  37. Stahl DO, Wilson PW (1995) On players’ models of other players: theory and experimental evidence. Games Econ Behav 10:218–254CrossRefGoogle Scholar
  38. Thaler RH, Tversky A, Kahneman D, Schwartz A (1997) The effect of myopia and loss aversion on risk taking: an experimental test. Q J Econ 112:647–661CrossRefGoogle Scholar
  39. Tom SM, Fox CR, Trepel C, Poldrack RA (2007) The neural basis of loss aversion in decision making under risk. Science 315:515–518CrossRefGoogle Scholar
  40. Tor A, Bazerman MH (2003) Focusing failures in competitive environments: explaining decision errors in the monty hall game, the acquiring a company problem, and multiparty ultimatums. J Behav Decis Mak 16:353–374CrossRefGoogle Scholar
  41. Wedell DH, Böckenholt U (1994) Contemplating single versus multiple encounters of a risky prospect. Am J Psychol 107:499–518CrossRefGoogle Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2014

Authors and Affiliations

  • Ido Erev
    • 1
  • Sharon Gilat-Yihyie
    • 2
  • Davide Marchiori
    • 3
  • Doron Sonsino
    • 4
  1. 1.Faculty of Industrial Engineering and ManagementTechnionHaifa Israel
  2. 2.Department of PsychologyWestern Galilee CollegeAcre Israel
  3. 3.Strategic Organization Design UnitUniversity of Southern DenmarkOdense M Denmark
  4. 4.The School of BusinessThe College of Management Academic StudiesRishon Lezion Israel

Personalised recommendations