Can Loss Chasing be explained by Behavioural Economic Theory?

Research by Xuan and Shaffer (2009) from The Division on Addictions (a Harvard teaching affiliate) sheds interesting light on our perceptions of loss chasing in relation to behavioural economic theory. Xuan and Shaffer analysed the play patterns of 226 online bwin gamblers who closed their accounts due to gambling problems. Their findings state that whilst players experienced increased monetary loss and increased their stake size prior to closing their accounts, they did not chase longer odds.

The authors frame their findings in the context of the work in the 1970s by Kahneman, Tversky and Slovic who analysed behavioural concepts and decision making, with Kahneman and Tversky’s paper in 1979, Prospect Theory: An Analysis of Decision under Risk, arguably one of the most important to be published in this field (Kahneman was awarded the Nobel prize for economics for his work in this field).

The group of gamblers in the Xuan and Shaffer study tried to recoup losses by increasing their stake on events with higher probabilities of winning i.e. they become more risk averse and, therefore, they bet more conservatively. However, the players did continue to bet with a greater stake size, albeit with less risky odds. Therefore whilst choosing less risky odds supports the theory of loss aversion, the fact they continued to bet using a different betting pattern perhaps adds less weight to the theory.  So I have an alternative theory that builds on this.

An additional explanation for the gamblers’ behaviours in this study could be the influence of cognitive biases such as regret theory, self-deception, over-confidence, and the sunk cost fallacy, rather than loss aversion. Jacobsen et al’s (2007) analysis of the influence of cognitive biases demonstrated that they play an important role in the development of problem gambling behaviour.  A study by Shefrin and Statman in 1984 that focused on loss realisation provides interesting insight into why investors tend to hold on to stocks that continue to lose value whilst selling performing stocks. One theory relates to avoiding regret, in that investors may resist realising losses as it is proof that their judgement is wrong. Their research also examined other emotional and psychological factors, such as mental accounting, where professional traders use heuristics, such as never letting their losses reach 10%, as a benchmark or anchor when to sell falling stocks.

Xuan and Shaffer’s paper provides a great insight into the gambling patterns of problem gamblers and their reference to loss aversion to explain gambling behaviours is very interesting and carries weight. In addition to loss aversion, other cognitive biases could have played an important role in the decision making process for gamblers as if they were truly loss averse, one can make the case that they would seek to limit their losses (like Shefrin and Statman’s traders) rather than to continue betting. Whilst many people today think there is very little difference between an investment banking trader and a casino gambler, I appreciate a direct comparison is too simplistic. One thing for sure is that this highlights the complexities involved in trying to get beneath the mind of a problem gambler.

Taming the ‘Inner Homer Simpson’ in you

As a student of and avid reader in the field of behavioral economics I wanted to mention Sunstien and Thaler’s ‘Nudge: Improving Decisions About Health, Wealth, and Happiness’ (here’s a good review of the book. The book’s an excellent read, and although there are some assertions I may not entirely agree with, it is highly relevant to what we are doing at Bet Buddy. The authors say that everyone’s "Inner Homer Simpson" drives us to make flawed decisions, such as eating too many cashews long after you stopped wanting one to paying insane fees on your credit cards. Why do we make these decisions? We live by rules of thumb, are influenced by irrational cognitive biases, and we live in a world of too many choices, with insufficient time and information to make the best one and little feedback about the stupid choices we've made in the past. So, the etching of black houseflies into the wells of the urinals at Schiphol Airport, under the theory that "if a man sees a fly, he aims at it”, reduced spillage by 80 percent, so was a good thing. And when the ATM beeps to remind you when you've walked away without your bank card is also a good thing. And giving players a gentle nudge or reminder if their play habits change is a good thing too.