Loss aversion is so easy to understand – it can be explained using a coin flip in ten seconds – and yet it manages to explain so many anomalies of modern life*, from the 4th down habits of football coaches to the collapsing real estate market:
The professors gathered data on almost 6,000 Boston condominium listings from 1991 to 1997 and showed that for essentially identical condominiums, people who had bought at the peak and were facing a loss generally listed their properties for significantly more than those who had bought at a time when prices were lower.
Properties listed above the market price just sat there. In the Boston market over all, sellers listed their properties for an average of 35 percent above the expected sale price, and less than 30 percent of the properties sold in fewer than 180 days. In other words, much of the market went into a deep freeze as many people held out for market prices that no one would reasonably pay.
In classical economics, that’s not supposed to happen, but the episode did comport with the behavioral economics theory of loss aversion: people have a visceral — some might say “irrational” — hatred of losing money. They try to avoid doing so, even when it goes against their own best interests.
That’s Austan Goolsbee in the Times. But is the reticence of home sellers a bad thing? It seems to me that the alternative is an instant deflation stock-market style, where the value of the investment can drop 5 percent in a single day. Now that would be depressing. Can you imagine coming home to a pile of bricks that is plummeting in value? It’s one thing to lose paper money in a stock portfolio; it’s another thing to live inside your losses. I think the loss aversion of homeowners is particularly strong, if only because nobody wants to get depressed every time they see their driveway.
*Perhaps the only psychological law which is equivalently simple and yet even more potent is adaptation/habituation. What do you think?