A Quickie Game of Loss Aversion
The human behavior that prefers one to avoid loss rather than make a gain is a phenomenon called Loss Aversion, Loss Aversion is easy enough to prove in real life. With a little experimentation, you can prove it by yourself.
Pick up a deck of playing cards and a couple of coins (or, more preferably, poker chips), approach your friends, and ask if they're willing to play a mini-game that involves buying and selling.
So this is how I did it.
I separated the high cards (Aces, Kings, Queens, and Jacks) from the ordinary cards.
I would show the high cards and have the person pick one he likes (I found out that most of my friends picked an Ace or King of Diamonds).
Afterward, I shuffled the ordinary cards, placed them face down, and dealt three cards to the person.
Without telling the rules of the game, the buying begins.
Using poker chips, I told the person that I wanted to buy any one of his cards. He doesn't have to show the cards to me. He'd just give me the card he wanted to sell.
My first offer was one poker chip.
Promptly, the person flipped over a 3 of Clubs.
I increased the offer. “I like to buy another card for three poker chips.”
I got a 6 of diamonds.
I followed this with five poker chips.
I got a 7 of Clubs.
Finally, I made the last offer of seven poker chips, which finally got me the Ace of Diamonds.
The simple logic here is that we tend to sell the high cards last because we think it has the highest value compared to the ordinary cards.
Moreover, because I let them pick the high cards they liked first, they tend to develop some form of ownership on it. If they sold the high card at a low amount would result in a feeling loss. So to avoid loss aversion, people tend to sell the high cards last.
In the next couple of experiments I decided to throw some curve-balls and got some pretty interesting reactions.
Again, without telling the rules of the game, I dealt with persons with three ordinary cards and made them pick the high cards they liked.
I began by offering 1 poker chip, 3 poker chips, and then 5 poker chips successively. Each time, I received an ordinary card. None of my participants handed their high cards.
The last offer, I went back down to 1 poker chip.
I noticed that when people heard my last offer, they were hesitant to hand me their high cards. They will often pause before handing me their Aces/Kings/Queens, or ask me why I lowered my offer on their last card.
This momentary bargaining period is a simple proof of loss aversion. They don't want to lose.
I tweaked the experiment again. This time, my goal was to make people sell their high cards first with the lowest amount of chips.
So after the players picked up their high cards and randomly got their ordinary cards, I specifically said that, in this game, the cards have no value; that they are all equal and the same.
With the first offer of two poker chips, I expected to get at least one participant to hand me over a high card.
Still, none of them did.
Often the high cards turned up on the last offer--again because they liked those cards--they feel they own them.
Of course, I may be wrong with my conclusion here since I have not replicated my experiment beyond 10 persons, but this card game gave me a glimpse of loss aversion at work.
Interestingly, this simple game also reflects the “endowment effect”, which I will be discussing (and making a game of) on my next blog.
Theodore Marc Gutierrez is a Registered Financial Planner (RFP), freelance writer, speaker, and researcher specializing in behavioral finance. Next to writing, he designs old school card/board games as a hobby. He published his first book, Astronomer's Tales, in 2007.