In an earlier post, we have seen Thaler’s observations on how prior outcomes (wins or losses) impact the behaviour of a decision-maker. Thaler designed experiments to understand such behaviours using Kahneman and Tversky’s prospect theory. His hypotheses are called editing rules, which suggest that people edit outcomes in the way that makes them happiest.
Further to the experimental results that we have seen before, Thaler went on to do more that led to modifications of the editing rules to quasi-hedonic editing rules. Let’s see what he found.
Segregate gains, integrate losses
Results of the first experiment made the impression that people like to spread gains (happiness). The opposite, integration of the losses, although hypothesised, was not observed always. For example, in the second question of the previous post, Mr A, who lost $100 and $50 in two separate instances, is more up-happy than Mr B, who lost $150 once.
Response of a rational thinker to losses
Following is an interesting, albeit perfect, set of answers from university students.
1) Lose $9 vs Lose $9 after having lost $30. Loss of $9 hurts more in: Most of the subjects chose the second option.
2) Lose $9 vs Lose $9 after having lost $250. Loss of $9 hurts more in: There was almost 50:50 for either.
You may be wondering if this is how things happen to real people. It could be true for people who are answering the question without having to lose anything! It could also be true for people who lose money from factors which were not entirely their fault. But what about players, such as gamblers? Well, that is for another time.
Richard Thaler and Eric Johnson, “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice”, Management Science, 1990.
