Imagine a coin toss in which you could win $50 for heads, but would lose $50 for tails. Would you take that bet?
What about winning $1,000,000 for heads, or losing $50 for tails?
Winning $75 or losing $50?
Most of us would not accept the first bet, but would certainly accept the second. The third option is a bit more ambiguous. Even though the potential gain is 50% greater than the potential loss, and the probability of each outcome is equal, most people would not take that third bet. Humans are peculiarly averse to risk; that is, we are more sensitive to potential losses than to potential gains. In fact, for the average person, losses are about twice as psychologically powerful as gains. Behavioral risk aversion (BRA) is the lowest Reward/Loss ratio an individual will accept. Since the average person will not take a 50/50 bet(such as a coin toss) unless the potential gain is at least twice as high as the potential risk, their BRA is about 2.
If you think about this logically, anyone with a BRA value greater or less than 1.0 is behaving irrationally (though not quite as irrationally as this man). If there is a 50/50 chance of gaining or losing money, one should feel neutral about accepting a bet for +$50/-$50, and accept all bets that have a greater potential pay-off than potential loss, including +$51/-$49. Accepting a +$51/-$49 gamble may seem foolhardy but if the game is fair, and enough coins are tossed, you will come out with a profit.
Of course, there are many instances in which our "irrational" aversion to loss is actually quite rational. For example, if a person only has $50, earning $50 would merely double their wealth. Although this outcome is desirable, it is too trivial to motivate risking complete bankruptcy. In this situation, a "rational" person should reject this gamble, for the sake of his or her survival. Thus, although our aversion to loss results from a distorted perception of reality (maintaining a greater subjective value for a loss relative to a gain), it can protect us from getting ourselves into dangerous situations.
Let's go back to the +$51/-$49 bet with 50/50 odds, and assume you have a bit more of a buffer in your bank account than in the previous example. Although the most logical decision would be to accept the bet, most people would not do so. Clearly, humans do not use their powers of reason alone. Our emotions play a powerful role in our assessment of risk, eliciting instinctive responses that are a product of millions of years of evolution. Indeed, loss aversion has been observed in capuchin monkeys and children as young as five, suggesting that it may be a fundamental adaptation of the primate brain.
How does our intuitive biology render the subjective impact of losses as significantly greater than that of gains? What happens in the brain? Are there specific circuits that deal with reason, contending with those that deal with emotion? Are there circuits that are triggered by potential loss, communicating with those triggered by potential gain? Or does risk evaluation involve a single neural system that assigns subjective value to both potential risks and losses? A team of researchers led by Russell Poldrack of UCLA explored these questions and claimed to find a link between certain brain areas and the innate aversion to risk, publishing their intriguing results in Science.
The researchers presented 16 college-aged subjects with 256 different combinations of potential gains and losses (e.g. +$36/-$20); all gambles were coin tosses bearing a 50% chance of either outcome. While the subjects decided whether or not to accept the bets, the researchers used functional magnetic resonance imaging (fMRI) to determine which areas of the brain were active. Analysis of the fMRI results revealed regions that became more active as the potential rewards grew and the bets became more attractive. These areas included the "reward centers," such as the prefrontal cortex and ventral striatum, which are also activated when eating chocolate, hearing pleasing music, and taking cocaine.
What about when the potential loss increased? Surprisingly, when the subjects evaluated the possibility of losing money, the areas associated with negative emotions, such as fear and anxiety, were not activated. In fact, there were no areas that became more activated in response to increased potential loss. Instead, such scenarios silenced the areas that had been activated in response to potential gain. Notably, these areas were turned down in response to potential loss more strongly than they were turned up by potential gain. In other words, the neural response to potential loss was stronger than the neural response to potential gain; the activity in these neural circuits thus mirrored the subjects' behavioral aversion to risk.
The researchers then looked at individual differences between subjects to determine the extent to which a person's brain activity could predict their aversion to loss. For each subject, the researchers analyzed the data from all 256 evaluations to determine their BRA. Across all subjects, the median BRA value was 1.93, and ranged from 0.99-6.75. When they focused on the brain activity of subjects who were least averse to risk (low BRAs), they found that these brains had the weakest responses to both potential losses and potential gains. These results indicate that relative to people who are risk averse, risk takers have an overall diminished response to both gains and losses. To take this result beyond a coin toss, this may provide a neural basis for why certain individuals are more likely to be involved in risky behaviors such as base jumping and stock trading: they seek greater gains regardless of the increasing potential loss because their brains are less sensitive to both.
Human irrationality and our inability to logically assess risk are fascinating phenomena, and this study is an exciting demonstration of a neural basis for this behavior.
Reference: Tom SM et al (2007). The neural basis of loss aversion in decision-making under risk. Science.