Windfall Gains and Investment Choices
86 Pages Posted: 22 Aug 2015 Last revised: 1 Dec 2016
Date Written: November 29, 2016
Economic theory assumes that investment choices do not depend on the source of the budget. We test this assumption using experimental and field evidence. In the experiments, we divide participants into two groups: those that obtain an endowment through a windfall and those that obtain the same amount through completing a physical effort task (the "hard-earned" group). We show that individuals in the hard-earned group make less risky and more patient choices than individuals in the windfall group. With field data from the stock market, we show that investment behavior after realization of a windfall gain is more risk taking than after a pedestrian realization of the same size: investors make more stock purchases and in more risky stocks. We conclude that windfall gains lead to more risky and less patient choices than more regular income. Our results support mental accounting theory and prospect theory, at the expense of economic theory.
Keywords: house money, risk preferences, time preferences, windfall gain
JEL Classification: C91, D14, E21
Suggested Citation: Suggested Citation