IDEAS home Printed from https://ideas.repec.org/a/aea/aecrev/v106y2016i8p2086-2109.html

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

Author

Listed:
  • Alex Imas

Abstract

Understanding how prior outcomes affect risk attitudes is critical for the study of choice under uncertainty. A large literature documents the significant influence of prior losses on risk attitudes. The findings appear contradictory: some studies find greater risk-taking after a loss, whereas others show the opposite—that people take on less risk. I reconcile these seemingly inconsistent findings by distinguishing between realized versus paper losses. Using new and existing data, I replicate prior findings and demonstrate that following a realized loss, individuals avoid risk; if the same loss is not realized, a paper loss, individuals take on greater risk.

Suggested Citation

  • Alex Imas, 2016. "The Realization Effect: Risk-Taking after Realized versus Paper Losses," American Economic Review, American Economic Association, vol. 106(8), pages 2086-2109, August.
    • Handle: RePEc:aea:aecrev:v:106:y:2016:i:8:p:2086-2109
    Note: DOI: 10.1257/aer.20140386
    as

    Download full text from publisher

    File URL: https://www.aeaweb.org/articles?id=10.1257/aer.20140386
    Download Restriction: no
    File URL: https://www.aeaweb.org/articles/attachments?retrieve=zoUfbptaurecw3keMuZf0gOzyTb9mZXU
    Download Restriction: no
    File URL: https://www.aeaweb.org/articles/attachments?retrieve=4ZSfDCFziV-RW5tks3Sg5f4z84SBhZtW
    Download Restriction: no
    File URL: https://www.aeaweb.org/articles/attachments?retrieve=Hu9ih7fcBwiOovNjLJaeZqEKMdZ8-opO
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Pagel, Michaela, 2013. "Expectations-Based Reference-Dependent Life-Cycle Consumption," MPRA Paper 47138, University Library of Munich, Germany.
    2. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
    3. Nicholas Barberis, 2012. "A Model of Casino Gambling," Management Science, INFORMS, vol. 58(1), pages 35-51, January.
    4. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    5. Loewenstein, George, 1996. "Out of Control: Visceral Influences on Behavior," Organizational Behavior and Human Decision Processes, Elsevier, vol. 65(3), pages 272-292, March.
    6. Sebastian Ebert & Philipp Strack, 2015. "Until the Bitter End: On Prospect Theory in a Dynamic Context," American Economic Review, American Economic Association, vol. 105(4), pages 1618-1633, April.
    7. Shefrin, Hersh & Statman, Meir, 1985. "The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, vol. 40(3), pages 777-790, July.
    8. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    9. Botond Kőszegi & Matthew Rabin, 2006. "A Model of Reference-Dependent Preferences," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(4), pages 1133-1165.
    10. Quang Nguyen & Colin Camerer & Tomomi Tanaka, 2010. "Risk and Time Preferences Linking Experimental and Household Data from Vietnam," Post-Print halshs-00547090, HAL.
    11. Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer, 2012. "Salience Theory of Choice Under Risk," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(3), pages 1243-1285.
    12. Tomomi Tanaka & Colin F. Camerer & Quang Nguyen, 2010. "Risk and Time Preferences: Linking Experimental and Household Survey Data from Vietnam," American Economic Review, American Economic Association, vol. 100(1), pages 557-571, March.
    13. Mohammed Abdellaoui, 2000. "Parameter-Free Elicitation of Utility and Probability Weighting Functions," Management Science, INFORMS, vol. 46(11), pages 1497-1512, November.
    14. Barberis, Nicholas & Xiong, Wei, 2012. "Realization utility," Journal of Financial Economics, Elsevier, vol. 104(2), pages 251-271.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Henderson, Vicky & Hobson, David & Tse, Alex S.L., 2018. "Probability weighting, stop-loss and the disposition effect," Journal of Economic Theory, Elsevier, vol. 178(C), pages 360-397.
    2. Stephen G Dimmock & Roy Kouwenberg & Olivia S Mitchell & Kim Peijnenburg, 2021. "Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field," The Review of Financial Studies, Society for Financial Studies, vol. 34(9), pages 4524-4563.
    3. Jakusch, Sven Thorsten & Meyer, Steffen & Hackethal, Andreas, 2019. "Taming models of prospect theory in the wild? Estimation of Vlcek and Hens (2011)," SAFE Working Paper Series 146, Leibniz Institute for Financial Research SAFE, revised 2019.
    4. Arjan Verschoor & Ben D’Exelle, 2022. "Probability weighting for losses and for gains among smallholder farmers in Uganda," Theory and Decision, Springer, vol. 92(1), pages 223-258, February.
    5. Campos-Vazquez, Raymundo M. & Cuilty, Emilio, 2014. "The role of emotions on risk aversion: A Prospect Theory experiment," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 50(C), pages 1-9.
    6. Hong Chao & Chun-Yu Ho & Xiangdong Qin, 2017. "Risk taking after absolute and relative wealth changes: The role of reference point adaptation," Journal of Risk and Uncertainty, Springer, vol. 54(2), pages 157-186, April.
    7. He, Xuedong & Hu, Sang, 2024. "Never stop or never start? Optimal stopping under a mixture of CPT and EUT preferences," Journal of Economic Theory, Elsevier, vol. 222(C).
    8. Ebert, Sebastian & Hilpert, Christian, 2019. "Skewness preference and the popularity of technical analysis," Journal of Banking & Finance, Elsevier, vol. 109(C).
    9. Nicole Hentschel, 2025. "Risk Attitudes do not explain Cash Holdings," Working Papers 25.04, Swiss National Bank, Study Center Gerzensee.
    10. Freudenreich, Hanna & Musshoff, Oliver & Wiercinski, Ben, "undated". "The Relationship between Farmers' Shock Experiences and their Uncertainty Preferences - Experimental Evidence from Mexico," GlobalFood Discussion Papers 256212, Georg-August-Universitaet Goettingen, GlobalFood, Department of Agricultural Economics and Rural Development.
    11. Jakusch, Sven Thorsten, 2017. "On the applicability of maximum likelihood methods: From experimental to financial data," SAFE Working Paper Series 148, Leibniz Institute for Financial Research SAFE, revised 2017.
    12. Géraldine Bocquého & Julien Jacob & Marielle Brunette, 2020. "Prospect theory in experiments : behaviour in loss domain and framing effects," Working Papers hal-02987294, HAL.
    13. Heutel, Garth, 2019. "Prospect theory and energy efficiency," Journal of Environmental Economics and Management, Elsevier, vol. 96(C), pages 236-254.
    14. Cristiana Cerqueira Leal & Gilberto Loureiro & Manuel J. Rocha Armada, 2018. "Selling winners, buying losers: Mental decision rules of individual investors on their holdings," European Financial Management, European Financial Management Association, vol. 24(3), pages 362-386, June.
    15. Jin, Xiaoye, 2022. "Testing technical trading strategies on China's equity ETFs: A skewness perspective," Emerging Markets Review, Elsevier, vol. 51(PA).
    16. Markus Dertwinkel‐Kalt & Jonas Frey, 2024. "Optimal Stopping In A Dynamic Salience Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 65(2), pages 885-913, May.
    17. B. Douglas Bernheim & Charles Sprenger, 2020. "On the Empirical Validity of Cumulative Prospect Theory: Experimental Evidence of Rank‐Independent Probability Weighting," Econometrica, Econometric Society, vol. 88(4), pages 1363-1409, July.
    18. Ryan O. Murphy & Robert H. W. ten Brincke, 2018. "Hierarchical Maximum Likelihood Parameter Estimation for Cumulative Prospect Theory: Improving the Reliability of Individual Risk Parameter Estimates," Management Science, INFORMS, vol. 64(1), pages 308-328, January.
    19. Aurélien Baillon & Han Bleichrodt & Vitalie Spinu, 2020. "Searching for the Reference Point," Management Science, INFORMS, vol. 66(1), pages 93-112, January.
    20. Kpegli, Yao Thibaut & Corgnet, Brice & Zylbersztejn, Adam, 2023. "All at once! A comprehensive and tractable semi-parametric method to elicit prospect theory components," Journal of Mathematical Economics, Elsevier, vol. 104(C).

    More about this item

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:aea:aecrev:v:106:y:2016:i:8:p:2086-2109. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Michael P. Albert (email available below). General contact details of provider: https://edirc.repec.org/data/aeaaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.