I’m having difficulty getting a strong grasp on the difference btw these, can someone help explain? It seems like both definitions say that in each case, an investor experiences a greater loss in utility for a given loss than a gain in utility from an equal gain.
Risk aversion is where someone does not like taking risk, so will invest in rfr, money markets, short term govies etc… They have no interest in small cap stocks, far too risky!
Loss aversion, being an emotional bias suddenly makes things more complicated. This relates to selling winners early and hanging on to losing positions as they can’t bear to take the loss of the mark to market.
A risk averse investor, invests in safe non volatile investments, a loss averse investor may well be invested in risky assets classes, but emotionally can’t bring themselsves to take the loss.
Risk aversion : Typically the investor values gains and losses equally . Given an opportunity to make certain gains as opposed to uncertain ones , the investor would prefer the certainty. For two investments with equal expected returns , the investor would prefer the less risky asset.
Loss aversion: The investor values losses higher than gains. ( think of the S shaped curve with the lower part steeper and less satiated than the upper part ). In the event of a loss , the investor might prefer to take more risks to try and make up the loss ( a.k.a. doubling down ). The level of wealth matters more to the individual than the valuation of investments in terms of their future returns ,i.e. the investor might possess biased expectations
If you had an investment with a 50% chance of earning 10% per year and a 50% chance of earning 20% per year, and another investment with a guaranteed return of 15% per year, a risk averse investor would prefer the latter (no uncertainty), while a loss averse investor could easily prefer either (as neither involves loss).