This paper develops a new behavioral model of how experience affects willingness to trade
called adaptive loss aversion. In the model, agents do not recognize that others have different
information. Loss aversion makes them cautious. When trading, this protects them from being
exploited by better-informed traders. The degree of loss ...
This paper develops a new behavioral model of how experience affects willingness to trade
called adaptive loss aversion. In the model, agents do not recognize that others have different
information. Loss aversion makes them cautious. When trading, this protects them from being
exploited by better-informed traders. The degree of loss aversion λ is adjusted in response to
experience and carries over between games. When outcomes are better than anticipated, λ decreases; when outcomes are worse than anticipated, it increases. A repeated market experiment
with symmetric and asymmetric information is used to test the model. The data are noisier than
anticipated but some of the model’s main predictions are supported. A structural version of the
model is estimated using the experimental data and data from two previous experiments on the
winner’s curse. A range of other behavioral game theory models is also estimated using the same
data and the fit of the models is compared.
