The Realization Effect: Risk-Taking after Realized versus Paper Losses
American Economic Review · 2016 · Volume 106 · Issue 8
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.
Keywords
Consumer Economics: Theory, Household Saving, Personal Finance, Criteria for Decision-Making under Risk and Uncertainty, Portfolio Choice, Investment Decisions
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