Daniel Kahneman won a Nobel Prize for his work with Amos Tversky by demonstrating that a dollar is not always a dollar. While economists had long assumed that the pain attached to losing a dollar should be equal to the happiness of gaining a dollar, Kahneman and Tversky found that losing is much more painful than gaining. This simple finding was shown to have many different consequences. Think about it this way—as humans, we go about our lives generally trying to avoid losses.
While you might think that trying to avoid the pain of loss should lead to more cautious behaviors (and some research has shown this), Kahneman and Tversky found that aversion to loss can lead to riskier behaviors. Their most famous example of this is a scenario in which people are asked to pick between two different treatment options for an impending disease scenario. In these studies, the options for treatment are framed in terms of potential gains (people saved) versus potential losses (people lost). When the treatments are talked about in terms of people who might be saved, individuals are likely to choose relatively safe policies—they don't want to risk greater losses than necessary. However, when treatments are talked about in terms of people who might die, individuals are likely to choose relatively risky policies—they are willing to take the chance that a maximum number of victims might be saved. While this seems complicated, this same thinking plays out on TV game shows and daily life—when faced with a potentially large loss, where there is a chance that everything might work out okay, we are willing to take the chance.
The question is, what makes something a loss and what makes something a gain? Again, according to economists, a loss is something that diminishes your current state and a gain is something that improves upon your current state. However, recent research by Jona Linde and Joep Sonnemans at the University of Amsterdam suggests that we decide whether something is a loss or a gain depending on how other people are doing. We care more about our gains and losses in relation to other people's gains and losses, than about our gains and losses relative to ourselves.
To test this idea, Linde and Sonnemans put people into a very simple situation and then watched to see whether they chose more or less risky lotteries to win a cash prize. First, participants were coupled with a partner, who they were told was similar to them, and played a game designed to create a feeling of affiliation and connection. Then, they were given 42 trials in which they could choose between different lotteries. The lotteries determined the possible payoff for both themselves and their partner. For example, in a typical loss-framed trial, the possible outcomes included equal winnings of 20 euros for themselves and their partner, or a win of 20 euros for the partner and 4 euros for themselves. In a typical gain-framed trial, the possible outcomes included equal winnings of 4 euros for themselves and their partners or a win of 4 euros for the partner and 19 euros for themselves. In the loss-framed trial, the best that participants could do is equal their partner. In a gain-framed trial, the worst that participants could do is equal their partner.
So, what happened? Kahneman and Tversky would have predicted that people should have chosen the safest option when when they could earn more money (20 euros) and chosen the riskiest option when they could earn less money (4 euros). However, people behaved in the opposite way. People seemed to take into account how they would do relative to their partner. That is, when they could only do as well as their partners, regardless of how much actual money they would earn, people acted in riskier ways. As long as their was a chance that they could do better than their partners, they were willing to take greater risks. However, when they could do better than their partners (and not do worse), they acted more conservatively and were unwilling to take risks.
What does this mean in real life? It means that when we make decisions, we aren't always concerned about our own fiscal well-being. Rather than ensuring the biggest payout for ourselves, we act to make sure our payoff is bigger than the guy next door, and to make sure that we aren't falling behind the guy next door. That fear of falling behind can lead us to take larger risks than we should.