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Closing a mental account: the realization effect for gains and losses

Author

Listed:
  • Christoph Merkle

    (Aarhus University BSS
    Danish Finance Institute (DFI))

  • Jan Müller-Dethard

    (University of Mannheim)

  • Martin Weber

    (University of Mannheim
    CEPR)

Abstract

How do risk attitudes change after experiencing gains or losses? For the case of losses, Imas (Am Econ Rev 106:2086–2109, 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.

Suggested Citation

  • Christoph Merkle & Jan Müller-Dethard & Martin Weber, 2021. "Closing a mental account: the realization effect for gains and losses," Experimental Economics, Springer;Economic Science Association, vol. 24(1), pages 303-329, March.
    • Handle: RePEc:kap:expeco:v:24:y:2021:i:1:d:10.1007_s10683-020-09663-x
    DOI: 10.1007/s10683-020-09663-x
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