It’s Not My Money: An Experiment on Risk Aversion and the House-Money Effect
16 Pages Posted: 18 Feb 2010 Last revised: 23 Mar 2010
Date Written: January 8, 2010
The house-money effect – people’s tendency to be more daring with easily-gotten money – is a behavioral pattern that poses questions about the external validity of experiments in economics: to what extent do people behave in experiments like they would have in a real-life situation, given that they play with easily-gotten house money? We ran an economic experiment with 66 students to measure the house-money effect on their risk preferences. They received an amount of money with which they made risky decisions involving losses and gains; a treatment group got the money 21 days in advance and a control group got it the day of the experiment. We find that, when facing possible losses, people in the treatment group showed a lower tolerance to risk than people in the control group. If the players are assumed to have a CRRA utility function and to behave according to expected-utility theory, the risk-attitude adjustment corresponds to an average increase of 1 in their risk aversion coefficient. While the exact pattern of this house-money adjustment differs by gender, it is not possible to determine the sign of this gender effect unambiguously. In any case, it is advisable to include credible controls for the house-money effect in experimental work in economics.
Keywords: House-Money Effect, Risk Aversion, Prospect Theory, Economic Experiment, External Validity
JEL Classification: C91, D03, D81
Suggested Citation: Suggested Citation