Loss Aversion — Why Losing Hurts More Than Winning Feels Good

Kahneman and Tversky ran a simple experiment: they offered people a coin flip. Heads, they win £150. Tails, they lose £100. Expected value is positive. Most people refuse. Their research found that the pain of losing £100 feels approximately twice as powerful as the pleasure of gaining £150. This asymmetry — loss aversion — is one of the most expensive psychological tendencies an investor can carry.

Why This Matters

Prospect Theory, developed by Daniel Kahneman and Amos Tversky and published in 1979, is the central finding of behavioural economics. It describes how people actually evaluate gains and losses — not through the rational utility functions of classical economics, but through a value function that is asymmetric and reference-dependent. The key findings: losses loom approximately twice as large as equivalent gains in emotional impact. People evaluate outcomes relative to a reference point (typically the purchase price) rather than in absolute terms. The value function is concave for gains (diminishing sensitivity as gains grow larger) and convex for losses (diminishing sensitivity as losses grow larger). Together, these properties generate a specific pattern of risk-seeking and risk-aversion that has direct consequences for investment behaviour.