By Aaron Leonard 

An Overview of Loss Aversion

Imagine you are given the following bet: you will earn $X if a coin turns up heads but would lose $100 if the coin turns up tails. What value of X would be required in order for you to accept the bet?

It turns out that on average, humans require a $200 potential gain in order to accept the bet, or in other terms a 2:1 ratio of benefit to cost. This illustrates the behavioural phenomenon of loss aversion, where humans tend to feel losses about twice as much as gains. In the example of the coin toss,  the average utility gained from winning the $200 is equivalent to the disutility of losing the $100 (i.e. “losses loom larger than gains”). In the case of these lotteries, subjects will often reject lotteries with a positive expected value as it contains the possibility of a loss, violating expected utility theory. The concept of loss aversion was first proposed in the Prospect Theory by Daniel Kahneman and Amos Tversky in 1979, the foundation of the behavioural economics paradigm, earning Kahneman the 2002 Nobel Prize in Economics.

Loss Aversion and Grades 

While extensive research on loss aversion has been published in the last thirty years, only a few studies have investigated how loss aversion affects student achievement on tests. Further, there is limited consensus on differences in performance between genders when framing is present. Gain framing is the traditional approach where scores start at 0% and go up to 100%, as opposed to loss framing where scores start at 100% and points are removed as mistakes are made.

Apostolova-Mihaylova (2015) looked at the impact of loss aversion when framing a final course grade as losing points for each incorrect answer, compared to gaining points for correct answers. No significant difference in mean performance was found. However, they uncovered a heterogeneous gender effect. Males performed better in the loss treatment group, whereas, females performed worse in the loss treatment group.

In contrast to Apostolova-Mihaylova (2015), McEvoy (2016), did not find a gender effect. However, in line with their hypothesis, students faced with loss treatment earned higher grades than the treatment gain group. The preliminary conclusion of the paper states that shifting the framing of course grades is a simple nudge to exploit loss aversion behaviour, and benefit students’ outcomes.

Smith (2018) also concludes that students perform better in the loss group, where each incorrect answer deducts points for errors on every evaluation. They conclude at the 1% level that loss group students outperform gain groups by 3 to 4% of the final course grade. However, this study also does not find a significant difference between genders, unable to replicate the results from Apostolova-Mihaylova (2015), concluding instead that it is unlikely there is a negative effect against females for loss framed class grades.

Gender Gap in Competitive Environments

The principal of a gender gap in entering and performing in competitive environments has been widely researched. Gneezy (2003) determines that women may be less effective in performance compared to men when in competitive environments. In non-competitive environments, there were no significant differences in performance between genders. Taking a different perspective, Niederle and Vesterlund (2007) examine differences in selection of tournament entry. The paper concluded that women only enter the tournament 35% of the time, compared to 73% of men. High-performing females did not enter the tournament enough, compared to the over entry of male participants. Rather, they concluded the overconfidence of males and differences in preference for competition explained this difference. The study finds that men overestimate their relative performance, which partially explains entry decisions.

Pilot Results 

To build off the current literature in the area, last year, I conducted a pilot study aimed to answer the following questions:

• Do loss framed multiple-choice (MC) quizzes improve performance?
• Do loss framed MC quizzes negatively bias male or female test takers?
• Do test takers with higher levels of loss aversion perform better or worse on loss framed multiple choice (MC) quizzes?
• Do entry costs to competitive environments negatively bias male or female test takers?

To conduct the experiment, participants completed an online survey consisting of demographic data, loss aversion measurement, and quizzes with standardised test questions. The control group faced questions framed as gains, and the treatment group with questions framed as losses. There were two quizzes in the research: the first quiz assigned a monetary prize randomly, while the second rewarded the highest score. Further, participants had the option of whether or not to enter the tournament for an associated cost. We investigated the differences between the random versus performance-based environment and competition entry.

Overall, the pilot project shows many promising conclusions surrounding the influence of loss framing on test outcomes and competitive environments, drawing on loss aversion behaviour. There are several main takeaways for this pilot, which all have statistical significance based on the online pilot survey.

• We find loss framing of multiple-choice quizzes improves test scores by 5-10% compared to traditional gain framing. This suggests loss framing could be effective as a nudge in educational institutions. This conclusion is consistent to McEvoy (2016) and Smith (2018).
• We find this improvement in test scores to be around twice as large in magnitude in the competitive environment compared to non-competitive random draw.
• We find loss framing of multiple-choice quizzes does not negatively bias male or female test-takers.
• We find that higher or lower levels of loss aversion are not associated with better or worse performance on multiple-choice loss or gain framed questions. This suggests the level of loss aversion does not significantly influence the mean score, but rather the general loss aversion of humans causes the increase in test scores.
• We find that females significantly under select entry into the competition stage compared to males (78% of males entered the competition, while only 48% of females did). This gender difference is consistent to Niederle and Vesterlund (2007), while we also hypothesise that gender difference can be partially attributed to difference in loss aversion scores.

The conclusions to this research suggest policy implications in any environment where an organisation would like to improve people’s scores in exams. Educational institutions, for instance, should consider changing the framing of student’s grade to the loss structure. Further, the competition results indicate that people should consider gender differences in competition entry and the potential influence of loss aversion. This could be especially pertinent in the workforce when organisation’s design promotion competitions and hiring decisions.

Ultimately, the goal of an organisation is to create an environment for people to reach their full potential without inherently marginalising a specific demographic group, such as gender. The conclusions in this paper can help guide more effective decisions to promote this success.

References

Abdellaoui, M., Han Bleichrodt, H., Paraschiv, C. (2007). Loss Aversion Under Prospect Theory: A Parameter-Free Measurement. Management Science, 53(10), 1659-1674.

Apostolova‐Mihaylova, M., Cooper, W., Hoyt G., Marshall, E. (2015). Heterogeneous gender effects under loss aversion in the economics classroom: A field experiment. Southern Economic Journal, 81(4), 980-994.

Gachter, S., Johnson, E., Herrmann, A. (2010). Individual-level loss aversion in riskless and risky choices. The Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham, Discussion Papers 2010-20.

Gneezy, U., Niederle, M., Rustichini, A. (2003). Performance in Competitive Environments: Gender Differences. The Quarterly Journal of Economics, 118(3), 1049–1074.

McEvoy, D. (2016). Loss Aversion and Student Achievement. Economics Bulletin, 36(3), 1762-1770.

NiederleM., Vesterlund, L. (2007). Do Women Shy Away From Competition? Do Men Compete Too Much? The Quarterly Journal of Economics, 122(3), 1067–1101.

Smith, B., Shrader, R., White, D., Wooten, J., Dogbey, J., Nath, S., O’Hara, M., Xu, N., Rosenman, R. (2018). Improving Student Performance through Loss Aversion. Available at SSRN: https://ssrn.com/abstract=3048028 or http://dx.doi.org/10.2139/ssrn.3048028.