Behavioral finance FAQ / Glossary (Aversion)

A    B    C    D    E    F    G-H    I-L    M    N-O    P-Q    R    S    T-U    V-Z

Full list

This is a separate page of the A section of the Glossary

 

Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

(disappointment, loss, risk, regret, uncertainty...) Averse, Aversion


See "aversion, disposition and
prospects", disappointment,
loss
aversion, risk aversion, regret
aversion, uncertainty aversion...

To invest money can give you

- either the feeling of becoming a nabob
- or the aversion of swinging a leg in a crocodile pond.

Aversion-related phenomena in investment,
    borrowing,
business, economics

Aversion is an attitude that expresses a pain (the same as attraction
is -usually - related  to a pleasure) when facing some situations.

It is found also when having to take some decisions and to do some
actions.

Definition: Aversion is a painful feeling in the 

form of a dislike, an hostility, a negative
attitude
(see "attitude") towards something (or somebody).

It activates a suffering in a particular emotional brain area (see
neurosciences).

Some neurons are nagging!

  General effects:

In decision-making and the related behaviors, aversion brings:

Most of the time, a reluctance to act.

Sometimes, a more personalized hostility or even

hate that leads to resist, fight or eliminate
whoever is considered the "culprit".


The opposite attitude is liking, based on an impression of

pleasure, an attraction towards something / somebody

In between liking and aversion, there is the neutral or tolerant
attitude.

Aversion can cause various kinds of biased behaviors.

Typical ones are found in moves - or lack of moves - related to
money matters.

Here, when a possible loss is at stake, various phenomena under

the "aversion" umbrella can appear:

Risk aversion (see that phrase) is one of the oldest
                 economic concept.

It leads to the expected utility (see that phrase) notion.

It leads to, when having the choice:

To opt for a situation or a behavior that allows to
   get
or keep an amount of money without risk,

Than to choose one that gives the possibility to get
   a bigger amount,
but with the risk of

getting nothing (or of losing something).

"Better be safe than sorry", is the feeling behind this.


  Uncertainty aversion (see uncertainty). is
                              an attitude related to risk aversion.

It takes place when probabilities are not statistically known
and probability
laws do not fully apply.

This is often the case in markets, whatever is said about "statistical
risk", or about "volatility" that only show the "ordinary" risk, the
"historical" one, or even more short-sighted, the "recent" one.

Uncertainty tends to incite:

Either, paradoxically, to stick to a false certainty
   feeling
...

* by ignoring, neglecting or denying - possible scenarios and
   new situations that do not fit already known data (see 
  
numeracy bias) and/or clear-cut probability laws (see
   distribution),

* even by building - or adhering to - beliefs and pseudo
   certainties  to explain unclear situations and make
   predictions.

Or on the contrary to create an exaggerated fear
   of uncertainty
.


Loss aversion and regret aversion are other
    types.

They are explained in the "aversion, disposition and
prospects"
article below.

Aversion, disposition and prospects

(Synthesis article on those various concepts)




 

This article compares for clarification,
various notions
from the glossary
partly related to one another:

* Risk aversion, loss aversion, regret

aversion, disappointment aversion,

* Prospect theory, disposition effect,
   endowment effect...

Hamletian reluctance to do or not to do certain things?

Prospect theory and reference price

To sum it up, people have
a much higher hate of losses
than a love of gains.


The prospect theory (see that phrase) complement the risk aversion notion.
That theory addresses usually:

Assets already owned (there is here a relation with the
    disposition effect as seen below),

It can sometimes apply to new commitments also, as an aversion to take
them.

A reference price for such assets (see reference point),

It is for example the buying price, an historical high market price,

or a price objective including an expected gain, etc.

That theory states that, when calculated
from the same reference price (for example the buying price):

The disutility
    (= displeasure)
of 

a prospective loss

Is higher

than

The utility (= pleasure) 

of a prospective gain 
of the same amount

For example, people would usually accept to risk a loss of 100
Euros only if they expect
to gain much more than 100
Euros (typically 200 or 300 Euros) (*)

(*) Expected losses / gains being defined as foreseeable gains /
      losses multiplied
by their probabilities (see an example in the
      "expected value" article).

The difference with the plain risk aversion is that the comparison is made

Not only between two investments with fully opposite traits: a risky and
    a riskless one,

But, for the risky investment itself, between its downside and upside
    prospects,

And / or between two risky investments.

What is more irrational, is that loss aversion is not based
on future risk
or on utility, and that it can lead to
risk taking on already losing operations.

Although called the "prospect" theory it applies not only to future gains and
losses but also to actual ones, the eggs already broken.

Moreover, it gives explanations on loss aversion, regret aversion and more
generally the disposition effect (see below those three concepts).

Disposition effect and regret / loss aversion

Sorry, what is mine is not for sale.

1) Disposition effect

The disposition effect (see that phrase) is a widespread asset

owner's aversion to sell unless getting what is considered
a "good price",

This wanted price can be called a reference price,
but not necessarily the one triggered by the loss aversion.


This is a bit different from the endowment effect, which is

somebody's reluctance to sell an asset it owns whatever the
price
.

It differs also from the loss aversion, in which the reference 

price is usually the buying price, as seen below.

2) Regret / loss aversion

The disposition effect, which exists by itself, is reinforced by other types of
aversions when the unfavorable price situation entails a regret or
loss.

But it can be compensated if the regret or loss diminishes
(for example after a price rise, even if it does not compensate the loss
fully).

The regret aversion (see that phrase) is one of the causes of

the general aversion to sell whatever the price...

...whether there is or not a reference point

...and whatever the kind of reference (buying price, previous

price at which the asset could have been sold).


While the loss aversion is usually the aversion to sell

when comparing the present price to the buying price.

Anyway, the regret aversion or loss aversion:

Can be stronger for a specific asset, for which the investor feels
    guilty to
have made a bad choice when he bought it,

...than for a stock which prices evolved like the whole market;

which makes him think the evolution is independent from his decision.

In that last case, there is only a disappointment effect /
aversion
(see that phrase).

The regret aversion (see the detailed article) can also apply to a missed
buying opportunity,while the loss aversion can give an explanation to the
reluctance to sell old assets to buy new ones.

Also a person has less regret after making a bad decision but that matched 
what the majority of the other players decided, than when its decision
deviated from the consensus.

When regret / loss aversion can oppose
    risk aversion.


When the price is below their reference price people are usually more

loss averse than   risk adverse, they prefer the risk to go on betting
on
a horse than to accept what that horse already lost.

This shows that, perversely, loss aversion can lead to
   risk seeking
.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

Members of the Behavioral Finance Group,
 please vote on the glossary quality at
BF polls

separ

This page last update: 25/07/15          

    A section of the Glossary
Behavioral-Finance Gallery main page

  Disclaimer / Avertissement légal