A psychological law of inertia and the illusion of loss aversion

Judgment and Decision Making, Vol. 1, No. 1, July 2006, pp. 23–32
A psychological law of inertia and the illusion of loss aversion
David Gal?
Graduate School of Business
Stanford University
Abstract
The principle of loss aversion is thought to explain a wide range of anomalous phenomena involving tradeoffs between
losses and gains. In this article, I show that the anomalies loss aversion was introduced to explain — the risky bet
premium, the endowment effect, and the status-quo bias — are characterized not only by a loss/gain tradeoff, but by a
tradeoff between the status-quo and change; and, that a propensity towards the status-quo in the latter tradeoff is suf?cient
to explain these phenomena. Moreover, I show that two basic psychological principles — (1) that motives drive behavior;
and (2) that preferences tend to be fuzzy and ill-de?ned — imply the existence of a robust and fundamental propensity
of this sort. Thus, a loss aversion principle is rendered super?uous to an account of the phenomena it was introduced to
explain.
Keywords: inertia, loss aversion, endowment effect, status-quo bias, risky choice, reference-dependent preferences
An object at rest remains at rest and an object in mo-
loss aversion has similarly been cited widely to account,
tion remains in motion unless acted upon by an outside
inter alia, for the endowment effect (e.g., Sen & John-
force.
son, 1997; Strahilevitz & Loewenstein, 1998), the com-
— Newton’s First Law of Motion (law of inertia)
promise effect (Simonson & Tversky, 1992), and an ob-
served asymmetry in the price elasticity of demand (Put-
ler, 1992; Hardie, Johnson, & Fader, 1993).
1 Introduction
The principle of loss aversion was ?rst introduced by
Research has shown that people tend to evaluate out-
Kahneman and Tversky (1979) to account for the ?nd-
comes not in terms of their impact on an individual’s re-
ing that experimental subjects required a premium over
sulting state of wealth, but in terms of changes from a
expected value to accept a bet offering an even chance
reference state (e.g., Kahneman & Tversky, 1979). More-
of a gain or loss (“the risky bet premium”). Subse-
over, evidence has been interpreted to imply that peo-
quently, the principle was extended to the context of risk-
ple are loss averse: negative changes (i.e., losses) from
less choice: Thaler (1980) coined the term “endowment
a reference state are thought to loom larger than positive
effect” to refer to the ?nding that randomly assigned own-
changes (i.e., gains) of equivalent magnitude (e.g Kah-
ers of an object appear to value the object more than ran-
neman & Tversky, 1979; Tversky & Kahneman, 1991).
domly assigned non-owners of the object. For instance, in
This principle, named loss aversion, is commonly consid-
one well-known series of endowment effect experiments,
ered the most robust and important ?nding of behavioral
Kahneman, Knetsch and Thaler (1990) found that ran-
decision theory, and has been widely hailed (Camerer,
domly assigned owners of a mug required signi?cantly
2005) and cited as a “seemingly ubiquitous phenomenon”
more money to part with their possession (around $7)
(Novemsky & Kahneman, 2005).
than randomly assigned buyers were willing to pay to
This seeming ubiquity is evident in the economics and
acquire it (around $3). Kahneman et al. (1990, 1991)
?nance literature, where loss aversion has been cited, in-
and Tversky and Kahneman (1991) attributed this result
ter alia, to account for the equity premium puzzle (Be-
to loss aversion: owners’ loss of the mug loomed larger
nartzi & Thaler, 1995), the disposition effect (O’Dean,
than buyers’ gain of the mug. “The status quo bias” —
1998), and the inability of risk-aversion based on wealth
individuals’ tendency to prefer to remain at the status-
to explain people’s unwillingness to accept small even
quo — is similarly attributed to loss aversion: It is as-
bets (Rabin & Thaler, 2001). In the marketing literature,
sumed that the loss of the status-quo option looms larger
than the gain of an alternative option (e.g., Kahneman et
?I am grateful to Michal Maimaran, Baba Shiv, Itamar Simonson,
al., 1991). For instance, in one empirical demonstration
Christian Wheeler, Barbara Mellers, the associate editor, and Jonathan
of the status-quo bias, Samuelson and Zeckhauser (1988)
Baron, the editor, for comments on earlier drafts of this manuscript.
Address correspondence to: David Gal, 729 Escondido Rd. #412, Stan-
showed that individuals participating in a hypothetical in-
ford, CA 94305, dgal@stanford.edu.
vestment choice task were more likely to choose to invest
23

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
24
an inheritance in a particular investment option (out of
and preferences for a propensity to remain at the status-
four) when that option was presented as the status-quo
quo. Subsequently, I compare this inertia account with
(i.e., when they were informed that the money from the
the loss aversion account for the status-quo bias, the en-
inheritance was already invested in that option).
dowment effect, and the risky bet premium. I conclude
Remarkably for a principle that is so pervasive, the
with the argument that the existence of a basic behav-
principle of loss aversion is not derived from any theory
ioral tendency to favor the status-quo over change ren-
of behavior or more basic psychological principles, but is
ders the loss aversion principle super?uous to an account
an ad hoc principle introduced to account for a range of
of the phenomena it was introduced to explain, and that
phenomena involving tradeoffs between losses and gains
the principle should therefore be abandoned.
that are anomalous in the context of the classical choice
paradigm. The absence of an accepted psychological the-
ory to account for loss aversion has led to a paradoxical
2 A psychological law of inertia
situation: loss aversion is cited as the explanation for phe-
nomena associated with loss/gain tradeoffs (e.g., the en-
In this section, I argue that a propensity to remain at the
dowment effect, status-quo bias, risky bet premium) and,
status quo, rather than a fundamental loss/gain asymme-
circuitously, the same phenomena are cited as evidence
try, offers the most parsimonious account for the phe-
for the existence of loss aversion.
nomena loss aversion was introduced to explain. That
This is not to say that loss aversion lacks a poten-
is, a propensity to remain at the status-quo logically fol-
tially plausible psychological basis. Indeed, a number
lows from basic, well-founded psychological principles,
of researchers have attempted to uncover an underlying
whereas loss aversion is an auxiliary principle, introduced
psychological mechanism that could explain a loss/gain
ad hoc to account for seemingly anomalous phenomena.
asymmetry. Posited psychological mechanisms for loss
In this section I show how psychological insights into
aversion include the proposition that the hedonic impact
the nature of behavior and preferences imply a robust ten-
of losses is greater than that of gains (e.g., Bar-Hillel
dency for people to remain at the status-quo in two parts:
& Neter, 1996), that people’s locus of attention tends
First the need for psychological motives to drive behavior
to be focused on losses more than on gains (Carmon &
implies that people will tend to remain at the status-quo
Ariely, 2000), and — through studies with either ani-
when they have no clear preference between the status-
mals or fMRI — that a loss/gain asymmetry is cognitively
quo and an alternative (or ‘change’) option. In addition,
hard-wired.
the fuzzy and ill-de?ned nature of preferences implies
A common feature of these attempts to uncover a psy-
that people will often have unclear preferences between
chological mechanism for loss aversion is the premise
options, and hence, that a propensity to remain at the sta-
that a fundamental loss/gain asymmetry in fact exists,
tus quo is likely to be a robust effect.
and that this asymmetry is re?ected in the phenomena it
purports to explain. In contrast, in the present research,
2.1 Motive-driven behavior
I do not attempt to explain the existence of a loss/gain
asymmetry, but to challenge the notion that a reference-
In the classical choice paradigm (Von Neumann & Mor-
dependent asymmetry is necessary to explain these phe-
genstern, 1944) of precise and well-de?ned preferences,
nomena at all. In particular, I recognize that the phe-
individuals making a choice between two options, A and
nomena most commonly cited as evidence for loss aver-
B, are thought to either (1) prefer A to B, (2) prefer B to
sion — the status-quo bias, the endowment effect, and
A, or (3) be indifferent between A and B (i.e., to prefer A
the risky bet premium — are characterized not only by
and B exactly the same). A particular preference order-
a loss/gain tradeoff, but by a tradeoff between the status-
ing is assumed to be independent of context, the descrip-
quo and change; and, that a propensity towards the status
tion of the problem, or the procedure used to elicit the
quo in the latter tradeoff is suf?cient to explain these phe-
preferences. Therefore, in the classical choice paradigm,
nomena. Moreover, I show that two basic psychological
preference for A or B should be the same regardless of
principles — (1) that motives drive behavior, and (2) that
whether option A or option B is the status-quo option.
preferences tend to be fuzzy and ill-de?ned — imply the
This implies that individuals who prefer option A to op-
existence of a robust and fundamental propensity of this
tion B should choose option A regardless of whether it is
sort. Thus, a propensity to remain at the status-quo —
the status-quo option or not; and, likewise, that individu-
i.e., inertia — is not simply an alternative account to loss
als who prefer option B to option A should choose option
aversion for these phenomena, but one that renders the
B regardless of whether it is the status quo option or not.
introduction of a loss aversion principle super?uous.
However, a question arises as to what individuals who
The remainder of this article is organized as follows:
are indifferent between Option A and Option B should
First, I discuss the implication of the nature of behavior
do. That is, what option should be chosen by individu-

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
25
als who have the same exact valuation for Options A and
A: Assuming precise and well-de?ned preferences:
B? Although such a situation is not addressed in the eco-
nomic literature, it seems clear that individuals who are
Indifference (status-quo preferred)
indifferent between two options should choose the sta-
A preferred to B
B preferred to A
tus quo. For instance, even in the absence of transaction
?
-
costs, we should not be surprised, in the context of pre-
Increase in absolute attractiveness of B
cise and well-de?ned preferences, if people “prefer” to
keep the dollar in their pocket rather than exchange it for
B: Assuming fuzzy and ill-de?ned preferences:
another dollar. This is because, at the most basic level,
economists and psychologists alike recognize that peo-
ple’s behavior is directed in accordance with psycholog-
A preferred
Fuzzy indifference range
B preferred
ical motives (i.e., reasons, drive states, goals, incentives,
to B
(status-quo preferred)
to A
etc.).
-
From this basic notion, it follows that people will not
Increase in absolute attractiveness of B
act to alter the status-quo unless they are impelled to do so
by some motive.1 Moreover, we can surmise that the pos-
Figure 1: Relative preference for Option A over Option
sibility of becoming better off — but not equally as well
B with increasing absolute attractiveness of Option B.
off — can provide the necessary motive to impel people
to change the status quo (see Figure 1A). This discussion
is formalized as follows:
accordingly, there is a tendency to remain at the status-
Psychological Law of Inertia: A person will
quo when people are indifferent between options. How-
tend to maintain the status-quo unless impelled
ever, I also acknowledged that the classical notion of pre-
to alter the status-quo by a psychological mo-
cise and well-de?ned preferences implies that indiffer-
tive to do so.
ence between nonidentical options is quite rare, and thus
any proclivity towards the status-quo is unlikely to be a
Corollary: The possibility of becoming better
robust effect.
off — but not equally as well off — can provide
the necessary motive to impel a person to alter
However, in recent times, the classical notion of pre-
the status-quo.
cise and well-de?ned preferences has been challenged
by a great deal of evidence, which has shown that pref-
As highlighted by the discussion to this point, the need
erences tend to be fuzzy and ill de?ned, and that they
for a psychological force, or motive, to alter the status-
are often constructed on an ad hoc basis (for review, see
quo implies that people can be expected to manifest a
Slovic, 1995; Bettman, Luce, & Payne, 1998). Moreover,
preference to remain at the status-quo when they are in-
evidence suggests that people are unable to precisely as-
different between options. However, such an effect is
sess the value of options and outcomes in an absolute
unlikely to be very robust in the context of precise and
sense (e.g., Hsee, 1996; Nowlis & Simonson, 1997). For
well-de?ned preferences, because such precise prefer-
instance, Kivetz and Simonson (2002) have shown that
ences make the likelihood of indifference between two
people tend to use the relative effort of others as a ref-
nonidentical options extremely slight. For instance, if an
erence to judge the absolute amount of effort associated
individual is indifferent between options A and B, then
with a frequency reward program. More speci?cally, they
the classical choice assumption of monotonic preferences
showed that if a “deal” is relatively better for person X
implies that the individual should prefer option A and a
than for the average individual, it will be extremely at-
penny to option B. Thus, given a large pool of individu-
tractive — to the point where it might be preferred over a
als, it is likely that only a minimal percentage of partici-
dominated option. In one experiment, Kivetz and Simon-
pants will value both options exactly the same, and these
son offered diners a reward program in which they could
individuals will thus have only a minimal impact on any
receive a free meal at a dining hall after having paid for
outcome that aggregates responses over this pool of indi-
a certain number of meals. In a between subject design,
viduals.
they found that sushi lovers would actually prefer a re-
ward program which required the purchase of 10 sand-
2.2 Fuzzy and ill-de?ned preferences
wiches and 10 sushi platters to a program which required
only the purchase of the 10 sandwiches. Although the for-
In the previous subsection, I argued that a change to the
mer option was dominated by the latter, sushi lovers per-
status quo requires a motive to alter the status-quo, and,
ceived a relative advantage in that they would likely have
1Throughout this article, “alter the status-quo” can be taken to in-
eaten the sushi anyway. Based on this relative advantage,
clude the similar case of “reject the default option.”
sushi lovers inferred that they were getting a “bargain” in

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
26
an absolute sense.
at the status quo. Proponents of loss aversion assert that
Research on choice deferral also suggests that people
a status-quo propensity is a consequence of a loss/gain
are unable to precisely judge the value of options in an
asymmetry (i.e., a reference-dependent asymmetry in fa-
absolute sense. For instance, Dhar (1997) ?nds that when
vor of losses), whereas the proposed inertia account as-
two options are rated similarly in terms of their attractive-
serts that any such asymmetry is auxiliary to an explana-
ness, people are likely to defer choice, rather than choose
tion of the basic behavioral propensity to remain at the
one of the two options. This suggests that people are un-
status-quo. Instead, the inertia account asserts that the
able to precisely judge the absolute attractiveness of the
status-quo bias logically follows from the basic principle
options and, accordingly, do not have a precise ordering
that behavior is directed in accordance with psychologi-
of preferences over the options that would allow them to
cal motives.
justify choosing one option over the other.
Clearly, the inertia account is more parsimonious than
If we extend this reasoning to a choice between any
the loss aversion account; however, is there a way to also
two options, A and B, then we can surmise that people
compare the descriptive validity of the inertia and loss
may be indifferent — i.e., have no clear preference —
aversion accounts as explanations for the status-quo bias?
between options A and B, and also have no clear prefer-
We can consider a thought experiment of the extreme case
ence between option A plus a penny and option B — and
where an individual has precisely identical valuations for
even between option A plus a dollar and option B. That
the status-quo option and an alternative option: would
is, fuzzy and ill-de?ned preferences imply a fuzzy range
an individual exchange the dollar bill in her pocket for
of absolute attractiveness values for option A, that are not
another, essentially identical, dollar bill absent some ex-
clearly differentiated in terms of relative attractiveness to
ternal motivation (e.g., a desire to comply with an ex-
option B — and vice versa (see Figure 1B). For exam-
perimenter’s request) to do so? An inertia account pre-
ple, if option A is a monetary amount and option B is
dicts that, absent an external motive, an individual will
a mug, it is possible that values of A between roughly
“choose” to retain her dollar bill rather than exchange it
$3 and roughly $7 will not feel suf?ciently different from
for a different dollar bill because of the absence of any
the value of the mug to induce a clear preference between
motive to exchange dollar bills.
the monetary amount and the mug. Similarly, if option A
In contrast, a loss aversion account makes no such pre-
is $5 and option B is a mug, people may have no clear
diction. This is because it is assumed (quite reasonably)
preference both between $5 and a mug with a standard
that people do not typically view an exchange of iden-
handle and between $5 and a mug with a fancy handle —
tical items as a tradeoff between a loss and a gain. For
even if they strongly prefer the fancy handle relative to
instance, Kahneman (2003) has stated that loss aversion
the standard handle.
should not be expected to apply in an exchange of ?ve $1
Thus, the recognition that preferences tend to be fuzzy
bills for a $5 bill. Similarly, Novemsky and Kahneman
and ill-de?ned suggests that people will often have un-
(2005, p. 123), in highlighting one of several proposed
clear preferences between two options. Accordingly, we
“boundaries of loss aversion,” surmise that “[A] shopper
can expect that people will often lack a motive to alter the
is unlikely to experience loss aversion when giving up a
status-quo.
good for a nearly identical one.”
Although a thought experiment is likely suf?cient, I
conducted a simple experiment to con?rm that the out-
3 Inertia versus loss aversion
come of a choice between two essentially identical op-
tions will signi?cantly favor the status-quo option (as pre-
dicted by the inertia account, but not by the loss aversion
In the previous section, I argued that the nature of be-
account). In a between subject design, 110 participants
havior and preferences imply a fundamental behavioral
— undergraduates at a large west coast university —
proclivity to prefer the status-quo to change. In this sec-
were asked to imagine that they owned a quarter minted
tion, I show that a propensity to remain at the status-quo
in either Denver or Philadelphia. They were then asked
can account for the status-quo bias, the endowment ef-
whether — given a choice — they would choose to switch
fect, and the risky bet premium — the phenomena most
their coin with a coin minted in the other city, assuming
widely cited as evidence for loss aversion — and do so in
insigni?cant time and effort involvement for the switch.
a more logically consistent manner.
Over 85% of participants in either condition chose to re-
tain their original coin, consistent with the inertia account
3.1 Status-quo bias and endowment effect
of the status-quo bias.
Although the experiment described above involved
As discussed earlier in this article, experimental evidence
goods that had well-de?ned relative valuations (i.e., their
has demonstrated that people have a tendency to remain
valuations were equal), people typically do not have well-

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
27
de?ned relative valuations for goods. Therefore, we can
expect that there will be many pairs of options for which
A
Fuzzy indifference range
Money
people will have no relative preference for one option
preferred
(status-quo preferred)
preferred
over the other (as between two quarters) — and hence
-
no reason or motive to alter the status-quo.
Increase in monetary sum
Thus, the inertia account can explain a propensity
towards the status-quo both when a status-quo option
Figure 2: Relative preference for a Good A over a vari-
and an alternative option have equivalent valuations and
able monetary sum.
when they do not. Conversely, a loss aversion account
is descriptively consistent with a propensity towards the
status-quo in cases where the status-quo option and an
alternative option are not equivalent, but it provides no
dence intervals rather than as point estimates. They de-
insight into why such a propensity persists when option
?ned the upper end of the WTP interval as “the small-
values are equivalent.
est amount a respondent de?nitely would not pay” for
a good and the lower end of the WTP interval as “the
largest amount a respondent de?nitely would pay.” Sim-
3.1.1 Endowment effect
ilar elicitation procedures were used to obtain the upper
As discussed earlier in this article, the endowment effect
and lower ends of respondents’ WTA interval. Dubourg
is the name for the ?nding that randomly assigned owners
et al. hypothesized that if imprecise preferences were the
of an object appear to value their possession more than
source of the endowment effect, then the WTP and WTA
randomly assigned non-owners.
range would overlap, but participants’ point estimates of
Because the status-quo bias and endowment effect are
their WTP might trend toward the lower WTP bound
such similar phenomena, the logic regarding inertia as an
and their point estimates of their WTA might trend to-
explanation of the status-quo bias in the previous subsec-
ward the upper bound of the WTA interval leading to a
tion extends fairly trivially to the endowment effect. For
WTP/WTA gap. Instead, they found that the entire WTP
instance, using the Kahneman et al., (1990) example of
interval tended to be well below the entire WTA interval.
buyers and sellers with divergent reservation prices for a
Thus, they surmised that imprecise preferences could not
mug, it is clear that sellers view ownership of the mug
wholly account for the WTP/WTA gap.
as the status-quo and non-ownership (plus receipt of pay-
Although the notion of imprecise preferences in
ment) as the change option. For buyers, the status-quo
Dubourg et al.’s account sounds similar to the notion that
and change options are reversed (see Figure 1B).
people often lack clear relative preferences between op-
Moreover, when one of the two options is a variable
tions, the manner in which Dubourg et al. operational-
monetary sum as in the Kahneman et al. (1990) experi-
ize a range of imprecise preferences does not equate to
ments, measures of maximum willingness to pay (WTP)
the fuzzy indifference range described by the inertia ac-
to acquire a good and minimum willingness to accept
count. Indeed, the inertia account predicts that measures
(WTA) to part with a good can be thought of as rough ap-
of WTP should be below measures of WTA because it
proximations to the fuzzy boundaries of the fuzzy indif-
is the gap between WTP and WTA that represents the
ference range depicted in Figure 1B. This is highlighted
fuzzy indifference range (i.e., the range over which peo-
in Figure 2, which can be viewed as an instance of Figure
ple do not have a clear preference for the money or the
1B where option B is a variable monetary sum. WTP rep-
good and hence do not trade due to the absence of a mo-
resents the lower boundary because at higher valuations
tive to trade.) Dubourg et al.’s use of different elicitation
there is either (a) indifference between the monetary sum
methods to obtain a range for each of WTP and WTA
and the good, or (b) the monetary sum is preferred to the
merely demonstrates that the borders of the indifference
good. Therefore, there is no motive for the individual to
range should not be thought of as clear demarcations be-
pay any more money for the good than the lower bound-
tween indifference and a clear preference for one option
ary of the fuzzy indifference range. Similar logic applies
over another, but as fuzzy and imprecise. Accordingly,
to WTA as the upper boundary of the indifference range.
different elicitation methods of WTP and WTA should
One potential challenge to the inertia account of the
be expected to yield different values for the borders of
endowment effect arises from the ?ndings of Dubourg,
the fuzzy indifference range. This is highlighted by the
Jones-Lee, and Loomes (1994). Dubourg et al. (1994)
short lines on either side of the long line in Figure 2.
found that the gap between their experimental partici-
The short lines represent possible ranges for WTP and
pants’ WTP and WTA persisted even after accounting for
WTA as found by Dubourg et al. (1994), whereas the long
“imprecise preferences.” Speci?cally, Dubourg et al. at-
lines between them represent particular point estimates of
tempted to de?ne participants’ WTP and WTA as con?-
WTP and WTA.

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
28
3.1.2 Degree of preference clarity
teresting assertion, because it is diametrically opposed to
the ?ndings and arguments of Loewenstein and Kahne-
Although the principle of loss aversion is agnostic about
man (1991) and Kahneman et al. (1991). Loewenstein
the magnitude of the loss aversion coef?cient (Daniel
and Kahneman (1991) found that despite the persistence
Kahneman, personal communication, 2004), several re-
of an endowment effect, experimental participants did not
searchers have sought to address this question empiri-
rate the attractiveness of endowed options more favorably
cally. In general, most researchers have concluded that
than the same options when they were not endowed. Kah-
the “coef?cient of loss aversion” is somewhere around 2
neman et al. (1991) interpreted this ?nding to imply that
(e.g., Tversky & Kahneman, 1992). However, other re-
the endowment effect does not “enhance the appeal of the
searchers have found that the degree of loss aversion de-
good one owns, only the pain of giving it up.” Thus, while
pends on the degree of similarity between options being
the status-quo label bias may be — under certain circum-
evaluated. For instance, unlike in the quarters experiment
stances — a complimentary contributor to a status-quo
presented earlier in this section, Chapman (1998) found
bias, evidence for a status-quo label bias does not appear
that a majority of experimental participants were willing
to support the loss aversion account over the inertia ac-
to trade items that they owned for identical items. More-
count of the status-quo bias.
over, Chapman showed that participants were more will-
ing to trade identical items than similar items and similar
items than dissimilar items. However, Chapman was able
3.2 Risky bet premium
to obtain these results only when she offered participants
The status-quo bias and endowment effect phenomena in-
a nickel for the act of trading in order to cover partici-
volve a loss/gain tradeoff that is entangled with a status-
pants’ “transaction costs.”
quo/change tradeoff. That is, the status-quo option is al-
The inertia account introduced in this article provides
ways associated with potential loss, whereas the change
insight into this ?nding whereas the loss aversion account
option is always associated with potential gain.
is silent. Speci?cally, the requirement for an incentive
At ?rst inspection, the risky bet premium phenomenon
— in the form of a nickel — to induce transactions for
does not appear to involve a status-quo/change tradeoff.
identical and similar items is in accord with the inertia
There appears to be only a tradeoff between the potential
account. When items being traded are identical or very
for loss associated with taking the bet and the potential
similar, relative preferences are well-de?ned — i.e., there
for gain associated with taking the bet. However, upon
is a relatively narrow range of absolute values of the op-
closer inspection, the risky bet premium phenomenon is
tions over which there is no clear preference between the
actually quite similar to the endowment effect and status-
options (i.e., a narrow indifference range in Figure 1B)
quo bias phenomena. In particular, in deciding whether
— and hence, even a slight increase in the value of the al-
to accept a single risky bet, the status-quo option is not
ternative option (e.g., an extra nickel) will be a suf?cient
taking the bet, whereas the change option is taking the
enough incentive for participants to alter the status-quo.
bet. That is, the decision to accept a single risky bet can
In other words, a participant asked to trade item X for
be thought of as a choice between two options, A and B,
item X will have no motive to do so; however a partici-
where Option A is not taking the bet (i.e., the status-quo)
pant asked to trade item X for item X + 5 cents can rec-
and Option B is taking the bet (i.e., the change option).
ognize that item X + 5 cents is clearly better than item
This is depicted in Figure 3, which can be viewed as an
X, and hence has a motive to execute the trade (absent
instance of Figure 1B where option A is the status-quo
transaction costs). On the other hand, if a participant has
and Option B is the status-quo plus a risky bet.
no clear preference between two dissimilar items, X and
Y, then she is also unlikely to have a clear preference be-
tween item X + 5 cents and item Y (see Figure 1B), and
SQ
Fuzzy indifference range
SQ+bet
therefore is likely to lack a motive to alter the status-quo
preferred
(SQ preferred)
preferred
with or without a nickel incentive.
-
Increase in X
3.1.3 Do people like the status-quo?
In recent research, Moshinsky and Bar-Hillel (2005)
Figure 3: Relative preference for status-quo (SQ) over SQ
found that participants tended to evaluate public pol-
plus a risky bet with 50% chance of losing $c and 50%
icy options more favorably when they were presented
chance of Winning $X.
as the status-quo option than when they were not, a
phenomenon they dubbed, the “status-quo label bias.”
The loss aversion account of the risky bet premium ig-
Moshinksy and Bar-Hillel (2005) argued that this ?nd-
nores the status-quo/change tradeoff. It asserts that peo-
ing constituted support for loss aversion. This is an in-
ple demand a premium over expected value to accept an

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
29
even bet because the potential for loss associated with
You will double your investment with a 50%
taking the bet looms larger than the potential for gain as-
chance.
sociated with taking the bet. This, of course, is premised
You will lose your investment with a 50%
on the belief that, objectively, people should judge the
chance.
value of risky prospects according to their expected value
Of my $100, I would invest $
in Option A
(e.g., Arrow, 1965).
and $
in Option B.
In reality, however, this presumption is a simpli?ca-
tion made so that risky prospects can be incorporated into
After a series of unrelated tasks, participants were also
rational (i.e., mathematical) theories of choice. There
asked — as in previous risky bet premium experiments
is, in fact, no demonstrably objective formula by which
— to indicate the premium they would require to accept
people should judge risky prospects. Instead, people
a single risky bet. The problem appeared as follows:
should judge risky prospects according to their goals:
they should weigh their desire to avoid potential loss
Single Risky Bet Task:
against their desire to acquire potential gains according
Suppose you were offered a risky bet that of-
to their preference for the tradeoff between them.
fered a 50% chance of losing $100 and a 50%
However, because this preference is likely to be fuzzy
chance of winning X. What is the least X
and ill-de?ned, there is likely to be a fuzzy range of val-
would have to be for you to be willing to take
ues for a prospect for which people will not have a clear
this bet?
preference between the prospect and the status-quo. For
instance, people may have no clear preference between
X would have to be $
.
the status-quo and a prospect featuring a 50% chance of
losing $100 and a 50% chance of gaining $100; and, they
3.2.1 Results
may also not have a clear preference between the status
In the single risky bet task — consistent with prior ?nd-
quo and a 50% chance of losing $100 and a 50% chance
ings — less than 2% of participants were willing to accept
of gaining $150. That is, they may not have a clear sense
an even bet, and the rest tended to require a signi?cant
that either bet, on balance, will tend to make them better
premium to accept the bet (median value of X was $500).
off than not taking the bet. Thus, people are likely to de-
In contrast, in the allocation task, 23% of participants
mand a premium to accept an even bet when they have no
allocated the entire monetary sum to the ‘even bet’ op-
preexisting psychological motive to alter the status-quo.
tion, 55% of participants allocated some of the monetary
To distinguish these competing accounts, I conducted
sum to the ‘even bet’ option and some to the ‘safe’ option,
a simple experiment, where participants faced a choice
and only 23% of participants allocated the entire mone-
between risky prospects that featured a tradeoff between
tary sum to the ‘safe’ option. Thus, the results of these
potential loss and potential gain, but no clear tradeoff be-
two tasks showed a robust requirement for a premium to
tween the status-quo and change. Speci?cally, experi-
accept an even bet only when participants were faced with
mental participants (133 undergraduates at a large west
a status-quo/change tradeoff (i.e., in the single risky bet
coast university) were asked to allocate a hypothetical
task). Indeed, this is the ?rst experiment to show that a
monetary sum between a risk-free (“safe”) option and an
large percentage of experimental participants — nearly
even bet. The problem featured no clear tradeoff between
80% — are willing to accept an even bet, a ?nding which
the status quo and change because the problem featured
challenges the most basic prediction of loss aversion (i.e.,
no clear status-quo option. The problem appeared as fol-
that people are unwilling to accept even bets.)
lows:2
Allocation Task:
3.2.2 Discussion
Assume you have $100 that you want to invest
The results of this experiment show that people demand a
and that the available options are the two in-
premium over expected value to accept a single bet with
vestment options below. How would you allo-
even odds of a gain or loss, but do not necessarily demand
cate your money between the 2 options?
such a premium when allocating funds across assets with
Investment Option A
different levels of risk (i.e., in a task with greater ecolog-
ical validity). At ?rst blush, one concern is that the allo-
You will make 3% on your investment for sure.
cation task may have prompted a demand effect, whereby
Investment Option B
participants assumed that the task was intended to elicit
allocations to both of the options. However, the ?nding
2The problem was the ?rst of six investment allocation type prob-
lems and participants were asked to assume that the duration of the in-
that nearly half of participants allocated the entire mone-
vestment in each problem was one year.
tary sum to a single option, and that of those participants,

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
30
half allocated the entire sum to the risky option, sug-
4 Does loss aversion exist?
gests that demand effects cannot explain the large share
of funds allocated to the risky option.
So far, in this article, I have argued that the notion that
motives drive behavior — together with the fuzzy and ill-
Another initial concern is that the sums participants
de?ned nature of preferences — necessarily implies a ba-
were asked to allocate were small. It is possible that par-
sic behavioral tendency to remain at the status-quo, with-
ticipants would have allocated a greater share of the mon-
out the need for any other auxiliary principle. I have also
etary sum to the safe option had participants been asked to
shown that this basic behavioral tendency is suf?cient for
allocate a sum that constituted a larger share of their bud-
explaining the existence of a status-quo bias, an endow-
gets or wealth. However, risky bet premium experiments
ment effect, and a risky bet premium, and that it provides
are typically conducted with small sums of money, be-
a more logically consistent account for these phenomena
cause it has been recognized that larger sums will lead to
than loss aversion.
an increasing impact of wealth, budgets and other classi-
Given this inertia account, what are the implications
cal economic variables on participants’ decision making
for the existence of loss aversion? To be sure, the exis-
(e.g., Kahneman & Tversky, 1979). Indeed, Rabin and
tence of inertia does not preclude the possibility that other
Thaler (2001) argue that it is the fact that people are so
in?uences also contribute to the complex phenomena in-
risk averse with such small sums of money that provides
vestigated in this article. Among those factors are antic-
the greatest support for the existence of loss aversion.
ipated regret, locus of attention, and the status-quo label
Thus, the ?ndings of this experiment are highly incon-
bias. Other research, however, casts further doubt on the
sistent with the loss aversion account, but consistent with
existence of a fundamental loss/gain asymmetry by chal-
the proposed inertia account of the risky bet premium.
lenging the evidence for loss aversion in phenomena that
involve a loss/gain tradeoff but not a status-quo/change
However, the fact that the evidence from this experi-
tradeoff. For instance, the equity premium puzzle —
ment is consistent with the inertia account does not imply
the ?nding that historical returns on stocks have signif-
that the evidence strongly supports the inertia account. I
icantly exceeded those on bonds (beyond what could be
have argued that the main difference between the allo-
explained by simple risk aversion) — has previously been
cation task and the single risky bet task is the absence
cited as evidence for loss aversion (Benartzi & Thaler,
of a clear status-quo option — and hence of a tradeoff
1995). However, Fama and French (2002) noted that us-
between the status-quo and change — in the allocation
ing historical data on returns alone is not very meaningful
task. An alternative account, however, is that the ma-
for judging the forward-looking equity premium — i.e.,
nipulations between tasks (e.g., temporal distance and
the returns investors could reasonably have expected at
choice vs. willingness-to-pay) simply led to a dramatic
the time. Fama and French (2002) estimated the forward-
shift in risk preference between tasks: participants were
looking equity premium to be substantially smaller than
risk-seeking in the allocation tasks and, a few minutes
the realized equity premium, obviating the need for a loss
later, dramatically risk-averse in the single risky bet task.
aversion explanation.3 Similarly, the scanner panel data
?nding by Hardie et al. (1993) that demand is more elas-
However, such a dramatic change in risk preference be-
tic for price increases than for price decreases was chal-
tween tasks seems implausible. Moreover, despite the su-
lenged by a study by Bell and Lattin (2000), who found
per?cial difference in risk preference expressed by partic-
no such asymmetry after controlling for the confounding
ipants across tasks — i.e., “risk-seeking” in the allocation
in?uence of heterogeneity in consumer price responsive-
task and “risk-averse” in the single risky bet task — there
ness.4
was a correlation in the decisions participants made be-
Even this evidence cannot disprove the existence of
tween tasks. Those participants who required the highest
loss aversion; but, the inability of researchers to ?nd ev-
premiums in the single risky bet task (based on a median
idence for loss aversion in these phenomena and its dis-
split) tended to allocate a greater part of their hypothet-
pensability to an account of the phenomena it was intro-
ical monetary sum (64% vs. 46%) to the safe option in
duced to explain — as highlighted by this article — do
the allocation task (t(131) = 2.71; p < 0.01). Thus, it
suggest that its existence may well be moot. An anal-
would appear that participants were, in fact, expressing
ogy from cosmological physics serves to highlight this
a real and relatively consistent underlying preference for
point. At the end of the nineteenth and start of the twen-
risk — i.e., for the tradeoff between potential loss and po-
tieth centuries cosmology faced an anomaly: Maxwell’s
tential gain — across tasks, but that this preference was
equations of electromagnetism required that light travel
being systematically shifted by an in?uence unrelated to
3Arnott and Bernstein (2002) estimated that the forward looking eq-
risk preference: a propensity to remain at the status quo
uity premium at the time of their study was zero or even negative
in the single risky bet task, but not in the allocation task.
4I thank Jim Lattin for reviewing this point.

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
31
at a constant rate, but Newtonian mechanics required all
keting Research, 42, 129–134.
motion to be relative. Hence, to resolve this anomaly,
Carmon, Z., & Ariely, D. (2000). Focusing on the for-
physicists posited the existence of a ‘luminiferous ether,’
gone: why value can appear so different to buyers and
a universal substance in space; light was thus thought to
sellers. Journal of Consumer Research, 27, 360–370.
move relative to the ether. Then, in 1905, Einstein’s the-
Chapman, G., (1998). Similarity and reluctance to trade.
ory of special relativity showed that if time was not ?xed
Journal of Behavioral Decision Making, 11, 47–58.
— an observation subsequently con?rmed by empirical
Dhar, R. (1997). Consumer preference for a no-choice
evidence — the presence of an ether was no longer re-
option. Journal of Consumer Research, 24, 215–231.
quired. Thus, relativity did not preclude the existence of
Dubourg, W. R., Jones-Lee, M. W., & Loomes, G. (1994).
the ether, but it did render its existence super?uous to an
Imprecise preferences and the WTP-WTA disparity.
explanation of the phenomenon it was introduced to ex-
Journal of Risk and Uncertainty, 9, 115–133.
plain. Accordingly, the concept of an ether was aban-
Fama, E. F., & French, K. R. (2002). The equity pre-
doned.
mium. Journal of Finance, 57, 637–660.
Analogously, a basic behavioral tendency to remain at
Hardie, B., Johnson, E. J., & Fader, P. (1993). Mod-
the status quo does not disprove the existence of a fun-
elling loss aversion and reference dependence effects
damental loss/gain asymmetry, but it does render its exis-
on brand choice. Marketing Science, 12, 378–394.
tence super?uous to an account of the phenomena it was
Hsee, C. K. (1996). The evaluability hypothesis: An ex-
introduced to explain. Indeed, given the fuzzy and ill-
planation for preference reversals between joint and
de?ned nature of preferences, and the need for a motive
separate evaluations of alternatives. Organizational
to drive behavior, we should be surprised if we did not ob-
Behavior and Human Decision Processes, 67, 247–
serve a status-quo bias, an endowment effect, and a risky
257
bet premium. Therefore, like the ether, logic dictates that
the principle of loss aversion be abandoned.5
Kahneman, D. (2003). A psychological perspective on
economics.
American Economic Review (Proceed-
ings), 93, 162–168.
References
Kahneman, D., Knetsch, J. L., & Thaler, R. (1990). Ex-
perimental tests of the endowment effect and the Coase
Arnott, R. D. & Bernstein, P. L. (2002). What risk pre-
theorem. Journal of Political Economy, 99, 1325–
mium is “normal”? Financial Analysts Journal, 58,
1348.
64–85.
Kahneman, D., Knetsch, J. L., & Thaler, R. (1991). The
Arrow, K. (1965). Aspects of the theory of risk-bearing.
endowment effect, loss aversion, and status-quo bias.
Helsinki: Yrjö Hahnsson Foundation.
Journal of Economic Perspectives, 5, 193–206.
Bell, D. & Lattin, J. (2000). Looking for loss aversion
Kahneman, D., & Tversky, A. (1979). Prospect theory:
in scanner panel data: the confounding effect of price
an analysis of decision under risk. Econometrica, 47,
response heterogeneity. Marketing Science, 19, 185–
263–291.
201.
Loewenstein, G., & Kahneman, D. (1991). Explaining
Bar-Hillel, M. & Neter, E. (1996). Why are people reluc-
the endowment effect. Working Paper, Carnegie Mel-
tant to exchange lottery tickets? Journal of Personality
lon University (data reported in Kahneman et al., 1991)
& Social Psychology, 70, 17–28.
Moshinsky, A., & Bar-Hillel, M. (2005). Loss aversion
Benartzi, S., & Thaler, R. (1995). Myopic loss aversion
and the status-quo label bias. Working Paper, Hebrew
and the equity premium puzzle. Quarterly Journal of
University.
Economics, 110, 73–92.
Nowlis, S. & Simonson, I. (1997). Attribute-task com-
Bettman, J., Luce, M., & Payne, J. (1998). Constructive
patibility as a determinant of consumer preference re-
consumer choice processes. Journal of Consumer Re-
versals. Journal of Marketing Research, 34, 205–218.
search, 25, 187–217
Novemsky, N. & Kahneman, D. (2005). The boundaries
Camerer, C. (2005). Three cheers–psychological, theo-
of loss aversion. Journal of Marketing Research, 42,
retical, empirical–for loss aversion. Journal of Mar-
119–128.
Odean, T., (1998). Are investors reluctant to realize their
5Abandoning loss aversion does not imply abandoning other ele-
losses? Journal of Finance, 53, 1775–1798.
ments of Prospect Theory’s value function. None of the arguments
made in this article in any way challenge the separate coding of losses
Putler, D, (1992). Incorporating reference price effects
and gains around a reference point, the concavity of the value function
into a theory of consumer choice. Marketing Science,
in the domain of gains, or the convexity of the value function in the do-
11, 287–309.
main of losses. This article merely challenges the notion that the loss
and gain curves are asymmetric (i.e., steeper in the domain of losses
Rabin, M., & Thaler, R. (2001). Risk Aversion. Journal
than in the domain of gains).
of Economic Perspectives, 15, 219–232.

---

Judgment and Decision Making, Vol. 1, No. 1, July 2006
Inertia and loss aversion
32
Samuelson, W., & Zeckhauser, R. (1988). Status-quo bias
Thaler, R. (1980). Toward a positive theory of consumer
in decision making, Journal of Risk and Uncertainty, 1,
choice. Journal of Economic Behavior and Organiza-
7–59.
tion, 1, 39–60.
Sen, S., & Johnson, E. J. (1997). Mere-possession ef-
Tversky, A., & Kahneman, D. (1991). Loss aversion in
fects without possession in consumer choice. Journal
riskless choice: a reference-dependent model. Quar-
of Consumer Research, 24, 105–117.
terly Journal of Economics, 106, 1039–1061.
Simonson, I., & Tversky, A. (1992). Choice in context:
Tversky, A., & Kahneman, D. (1992). Advances in
tradeoff contrast and extremeness aversion. Journal of
prospect theory: cumulative representations of uncer-
Marketing Research, 29, 281–295.
tainty. Journal of Risk and Uncertainty, 5, 297–323.
Slovic, P., (1995). The construction of preference. Amer-
Von Neumann, J., & Morgenstern, O. (1944). Theory of
ican Psychologist, 50, 364–371.
games and economic behavior. Princeton, NJ: Prince-
Strahilevitz, M. A., & Loewenstein, G. (1998). The ef-
ton University Press.
fect of ownership history on the valuation of objects.
Journal of Consumer Research, 25, 276–289.

---