“Essentially it explains the difference between willingness-to-pay and willingness-to-accept which is an endowment effect.”

I buy that most definitely.

“What you are painting as a definition is actually an observation that loss aversion can plausibly explain. It’s not a definition of it.”

My impression when I read it was that they were using this as an example of loss aversion. To me an example is like a loose way of defining something. Now in this case the same example could clearly be explained with diminishing marginal utility – which I think heavily reduces its usefulness as an example.

I have heard that example being used for explaining loss aversion 3 times in the last 2 weeks and I’m not comfortable with it – as I feel that there are too many plausible alternative explanations to make is a clear example of loss aversion.

I am genuinely concerned that this type of definition could lead to the concept of loss aversion being “over-applied” to cases where we are actually only observing diminishing marginal utility.

Essentially it explains the difference between willingness-to-pay and willingness-to-accept which is an endowment effect. Surely the $1000 gain/loss difference is about endowment. Either you have it and you're going to lose it or you don't have it and you're going to get it. Is the WTP for it less than the WTA for losing it? Yes, even for a risk neutral person. Obviously this is kinda backwards to value money in terms of a good that provides utility, but the principle holds.

"Ultimately, I am saying that framing loss aversion as “feeling sadder about a loss than a gain” is not a sufficient condition for the result – we could observe that in the absence of loss aversion."

I think that's the key: the bold doesn't define loss aversion, it describes an observation that we can explain with loss aversion. You could plausibly explain that simple observation many ways. However, the best way we have at the moment is loss aversion.

The full quote makes that clear:
"Their pioneering work addressed money illusion and other psychological foibles, such as our tendency to feel sadder about losing, say, $1,000 than feeling happy about gaining that same amount."

What you are painting as a definition is actually an observation that loss aversion can plausibly explain. It's not a definition of it.

“Loss aversion isn’t really about risk preference. You could be risk neutral and loss averse”

I thought that loss aversion directly implied that people’s revealed risk preference was asymmetric between gains and losses?

“The question you seem to be asking is “what experimental design could distinguish between loss aversion and diminishing marginal utility as explanations for an endowment effect?” Is that right? Cos if it is then I’ll look up a study when I have a minute.”

Sort of – if you look at the initial post the entire point was to ask if the definition in bold was an appropriate definition of loss aversion.

I wasn’t even arguing about the endowment effect because the definition didn’t say anything about the endowment effect. If it did, it would be closer to loss aversion.

With the endowment effect we find that people value something more highly when they have it right? So if you don’t own a cup you will pay $X for it, if you do own it you will only sell it for $X+$Y where Y>0. That is definitely loss aversion as you are measuring comparable conterfactuals.

In the definition in bold that is not the case. You currently have $10,000 and you illustrate that you are more hurt from losing $1,000 and having $9,000 than from gaining $1,000 and having $11,000. This doesn’t seem like an example of the endowment effect, and it doesn’t clearly illustrate loss aversion for me – especially given that the change in value could be the result of diminishing marginal utility.

Ultimately, I am saying that framing loss aversion as “feeling sadder about a loss than a gain” is not a sufficient condition for the result – we could observe that in the absence of loss aversion.

I feel that the definition in bold could be abused – my impression was that loss aversion was about reference dependence, and a asymmetric preference regarding the direction of change. If this is the case this is more specific than the idea that “people value a loss more heavily than a gain”

I’d also note that saying that they are risk averse in gains and risk loving in losses is the same as comparing it to an objective reference point, as in this – that is what PT does, and that is a way I am agreeing with.

I am disagreeing with the quote – which says that loss aversion (which is supposedly broader than PT) is simply a case where the pain of a loss exceeds the happiness of a gain. This seems incomplete to me.

“What’s important, surely, is having a static frame of reference so our reference point is the same for each scenario.”

Indeed. But if we don’t know the shape of the utility function then we can only say that this is the case if we are heading to the exact same point following each shock right?

If we assumed that diminishing marginal returns didn’t hold then we don’t have to worry – as treating a $10 loss differently to a $10 gain would imply loss aversion. But in the absence of that assumption I don’t see how it is clear.

“PT has diminishing sensitivity to changes in wealth, but the idea of diminishing marginal returns as the level of wealth increases don’t come into it, do they?”

My question depends on whether people have diminishing marginal returns to increases in the level of wealth – not whether it is assumed in PT.

As far as I know it is fair to assume that people have diminishing marginal returns to wealth – and as a result the above definition in bold could describe a situation that involves diminishing marginal utility and/or loss aversion.

In that sense, I don’t think it is fair to look at a person and say “since you are more concerned about losing $10 than you are happy about gaining $10 you are loss averse” as the actual outcomes associated with each of those $10 is different.

Thanks for your comments BTW rauparaha – I am sorry if I’m slow getting it 😛

This is the bit that doesn’t make sense to me. Why is ending up in the same place important if we don’t have an additive utility function? What’s important, surely, is having a static frame of reference so our reference point is the same for each scenario.

PT has diminishing sensitivity to changes in wealth, but the idea of diminishing marginal returns as the level of wealth increases don’t come into it, do they? If they did then the PT value function would be state dependent and I don’t think it is.

Also I would note that I am looking at revealed actions here – I want the appropriate counterfactual to discuss realised data. I can’t observe the shape of the utility function I can only observe actions – which is why I have a feeling the definition in bold in the post is a bit inappropriate for that.

I, in my intense lack of clarity, mean to say that “if we want to actually observe loss aversion we need a clear counterfactual”.

People keep saying “if we are hurt more by a loss than we enjoy a gain we are showing loss aversion” – but that doesn’t seem complete enough to me, because we can have diminishing marginal utility. As a result, I fear that people will take this definition, and apply it to cases where there is simply diminishing marginal utility.

However, if they can illustrate a case where someone values the loss more highly than the gain even though the eventual outcome is the same then it rules out diminishing marginal utility – and they can justifiably use the idea of loss aversion and discuss bounded rationality and any associated policy recommendations.