The prospect of a perfect ending: Loss aversion and the round-number bias

• We develop a theory of round-number bias via prospect theory and analog heuristics.
• We test the prediction that bias is greatest in choices involving loss (cf. gain).
• The theory is supported via analysis of both laboratory and real-world data.
• Findings reveal the importance of the editing phase in prospect theory.
• Findings have broad implications for inefficiencies in financial markets.

Studies across a range of domains have shown that individuals tend to focus on round numbers as cognitive reference points; a so-called left-digit effect. We explain this effect by combining analog numerical heuristics with prospect theory in order to develop an analog value function that predicts the key characteristics of the left-digit effect. Most importantly, this value function predicts an unreported phenomenon, namely; that the left-digit effect will be more pronounced in situations involving losses (cf. gains). We confirm this prediction in both a laboratory experiment regarding hypothetical investments and analysis of buy–sell imbalances in over 15 million trades by investors in a financial market. We conclude that our analog value function is a promising explanation for the left-digit effect. Furthermore, we suggest that interventions aimed at reducing costly buy–sell imbalances in financial markets should focus on the decisions made by investors when they are facing loss.