Loss Aversion Under Prospect Theory: A Parameter-Free Measurement

TLDR

Loss aversion, formalized in prospect theory, is supported by diverse field and experimental data, but its quantification has been limited by the lack of a general preference‑based method to elicit utility for gains and losses simultaneously, and multiple definitions have been proposed. The authors aim to overcome this gap by proposing a general, parameter‑free method to elicit utility for gains and losses simultaneously and applying it to measure loss aversion in an experimental study. The method involves a preference‑based elicitation procedure that simultaneously captures utility for gains and losses without imposing parametric assumptions, enabling a full‑domain, parameter‑free estimation of prospect theory’s utility function. The approach delivers the first parameter‑free elicitation of prospect theory’s utility function across the entire domain, efficiently elicits utility midpoints, and demonstrates strong evidence of loss aversion at both aggregate and individual levels, though the degree varies with definition, underscoring the need for a common definition.

Abstract

Agrowing body of qualitative evidence shows that loss aversion, a phenomenon formalized in prospect theory, can explain a variety of field and experimental data. Quantifications of loss aversion are, however, hindered by the absence of a general preference-based method to elicit the utility for gains and losses simultaneously. This paper proposes such a method and uses it to measure loss aversion in an experimental study without making any parametric assumptions. Thus, it is the first to obtain a parameter-free elicitation of prospect theory's utility function on the whole domain. Our method also provides an efficient way to elicit utility midpoints, which are important in axiomatizations of utility. Several definitions of loss aversion have been put forward in the literature. According to most definitions we find strong evidence of loss aversion, at both the aggregate and the individual level. The degree of loss aversion varies with the definition used, which underlines the need for a commonly accepted definition of loss aversion.