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

Published in Experimental Economics, 2020

Recommended citation: Merkle, Christoph, Jan Müller-Dethard, and Martin Weber. (2020). "Closing a Mental Account: The Realization Effect for Gains and Losses." Experimental Economics. forthcoming.

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.

Open access journal version

JEL codes: D11, D14, D81, G11.

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