Question

What is the difference between risk aversion and loss aversion?

Answer 1

The key differences of Risk aversion and loss aversion are as follows :

The Term aversion means is to prevent from any negative impact from such activity that you are willing to do but due to the negative impact possibility hesitates you to agree to a situation.

Risk Aversion

Risk aversion is the behaviour of the consumers and investors they try to lower the uncertainity so the aversion is common in both risk and loss.

For example - In the guaranteed scenario the person receives $100. In the uncertain scenario whether the person receives $150 or nothing. In both cases he will get $100, meaning that an individual who is ready take risk would not care whether they took the guaranteed payment or want to gamble.

The expected utility of the above bet (with a 50% chance of receiving 100 and a 50% chance of receiving 0) is

E(u) = (u(0) + u(100)) / 2

Loss Aversion

Loss aversion refers to the possibility of the consumer and investors to avoid losses losses to get equal gains.

Loss aversion was first identified by Amos Tversky and Daniel Kahneman.

Loss aversion shows that one who loses $200 will lose satisfaction more than twice of another person will have satisfaction from a $200 gain.

Investors get affected by pain of the realization of loss and they will suffer pain of loss until the trade is closed.