Closing a Mental Account: The Realization Effect for Gains and Losses

Experimental Economics, forthcoming. Preprint version

62 Pages Posted: 17 Jun 2018 Last revised: 18 May 2020

See all articles by Christoph Merkle

Christoph Merkle

Aarhus University

Jan Müller-Dethard

University of Mannheim

Martin Weber

University of Mannheim - Department of Banking and Finance

Date Written: April 19, 2019

Abstract

How do risk attitudes change after experiencing gains or losses? For the case of losses, Imas (2016) shows that subsequent risk-taking behavior depends on whether these losses have been realized or not. After a realized loss, individuals' risk-taking decreases, whereas it increases after an unrealized (paper) loss. He refers to this asymmetry as the realization effect. In this study, we derive theoretical predictions for risk-taking after paper and realized gains, and for investment opportunities with different skewness. We experimentally test these predictions and, at the same time, replicate Imas' original study. Independent of a prior gain or loss, we show that subsequent risk-taking is higher when outcomes remain unrealized. However, we find no evidence of a realization effect for non-positively skewed lotteries. While the first result suggests that the effect is more general, the second result reveals its boundary conditions.

Keywords: Realization Effect, Mental Accounting, House Money Effect, Risk Taking

JEL Classification: D11, D14, D81, G11

Suggested Citation

Merkle, Christoph and Müller-Dethard, Jan and Weber, Martin, Closing a Mental Account: The Realization Effect for Gains and Losses (April 19, 2019). Experimental Economics, forthcoming. Preprint version, Available at SSRN: https://ssrn.com/abstract=3189076 or http://dx.doi.org/10.2139/ssrn.3189076

Christoph Merkle

Aarhus University ( email )

Nordre Ringgade 1
DK-8000 Aarhus C, 8000
Denmark

HOME PAGE: http://christophmerkle.github.io/

Jan Müller-Dethard (Contact Author)

University of Mannheim ( email )

Department of Finance, L9, 1-2
Mannheim, 68131
Germany

Martin Weber

University of Mannheim - Department of Banking and Finance ( email )

D-68131 Mannheim
Germany
+49 621 181 1532 (Phone)
+49 621 181 1534 (Fax)

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