Loss Aversion in Prospect Theory

Loss aversion, an important element in prospect theory, explains many types of psychological behavior. In this paper, we formally define an in-dex of loss aversion as a function of the location, to reflect gain/loss com-parisons. This index, different from the one defined by Kobberling and Wakker (2005), can be used to fully describe the characteristics of loss aversion without making strong assumption on the utility function. Dis-tinctions of our definition from the previous ones are discussed in details. We also attempt to fit the special classes of utility functions into our defi-nition. Indices of different decision makers ’ loss aversion can be compared through Yaari’s acceptance sets or asset demand in investment strategy. Generally speaking, the more loss averse the agent is, the smaller the acceptance set is and the less he will invest in risky asset