Loss Aversion

Topics: Decision theory, Investment, Prospect theory Pages: 2 (550 words) Published: February 17, 2013
“A Behavioral Study Of The Impact Of Loss Aversion on the Decision Making Of Individual Investors: In Context of Madhya Pradesh”

Decision-making is a complex activity. Decision-making can be defined as the process of choosing a particular alternative from a number of alternatives. Choosing from the alternatives is the most crucial challenge faced by the investors is in the area of investment. The principal objective of an investment is to make money. Investment decision making involves the process of identifying, evaluating, and selecting among projects that are likely to have a significant impact on the expected future income. Every investor differs from others in economic background, educational attainment level, age, race and sex. To face this challenge, one needs better insight, and understanding of human nature in the existing global perspective, plus development of fine skills and ability to get best out of investments.

Loss aversion is an important psychological concept which is receiving increasing attention in economic analysis. It has first been proposed by Kahneman and Tversky (1979) in the framework of prospect theory. This particular effect of behavioral economics explains why people are more motivated to avoid a loss than to acquire a similar gain. Itis the wiring that makes us feel more depressed at the loss of Rs. 100 than elated at winning the same amount of money. In a nutshell “Loss aversion shows that losses loom larger than gains; that is, individuals weigh losses more heavily than the gains.”

What does loss aversion mean for investors in the course of portfolio planning? Investors seek to achieve a certain level of return. They like it when they earn positive returns, but they hate it even more when the returns go negative. What causes this systematic asymmetry between an investor’s response to gain and loss—and how investors should deal with it when planning their investment strategies? Based on the asset’s return and volatility...
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