Abstract

http://ssrn.com/abstract=2403865
 


 



The Realization Effect: Risk-Taking after Realized versus Paper Losses


Alex Imas


Carnegie Mellon University - Department of Social and Decision Sciences

March 23, 2014


Abstract:     
Understanding how prior outcomes affect risk attitudes is critical for the study of choice under uncertainty. A large literature documents the influence of prior losses on subsequent risk attitudes. The findings appear contradictory: some studies find that people become more risk seeking after a loss, whereas others assert the opposite -- that they become more risk averse. In this paper, we show that these seemingly inconsistent findings can be explained by individuals' differential responses to realized versus paper losses. Following a realized loss, individuals avoid risk; if the loss has not been realized -- a paper loss -- individuals are more likely to chase their losses and take on even greater risk. We provide support for our framework using existing data and across two experiments. We also show that giving individuals flexibility in choosing when to realize losses can lead to lower earnings in environments where loss-chasing decreases expected returns. Drawing a distinction between paper and realized losses reconciles prior findings, and has important implications for contract design and optimal monitoring.

Keywords: dynamic risk attitudes, prior losses, choice bracketing

JEL Classification: D03, D81, G02

working papers series





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Date posted: March 4, 2014 ; Last revised: August 22, 2014

Suggested Citation

Imas, Alex, The Realization Effect: Risk-Taking after Realized versus Paper Losses (March 23, 2014). Available at SSRN: http://ssrn.com/abstract=2403865 or http://dx.doi.org/10.2139/ssrn.2403865

Contact Information

Alex Imas (Contact Author)
Carnegie Mellon University - Department of Social and Decision Sciences ( email )
Pittsburgh, PA 15213-3890
United States
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