Effects of Prior Outcomes on Risk-Preference in Dynamic Repeated Decision-Making

Abstract

Thaler and Johnson (1990) proposed the 'house money effect' (risk taking increases after a win) and 'break even effect' (risk taking increases after a loss when there's a chance to break even) to describe people's behavior in dynamic decision making. Obviously these phenomena exceeded the explanation of prospect theory. However, in the study by Thaler and Johnson (1990), the decision frame was manipulated in the paradigm of two-stage gamble choice, so that the effects of prior outcomes on the risk preference in dynamic repeated decision making scenarios remain a problem. In the present study, based on the paradigm of Demaree (2012), we would like to reaffirm the theoretical expectations of 'house money effect' and 'break even effect' and analyze the decision pattern in the roulette game scenario quantitatively. In order to constitute a dynamic repeated decision scenario with favorable ecological validity, a simulated roulette game was developed. Participants were asked to choose between options which stood for a range of numbers on the roulette (e.g., from 18 to 36) and decide the amount of wager to put on. After the roulette rolling, a specific number was given. If the number fell in the range ofthe option, the corresponding amount of 'money' (the token in the game) would be added to the bankroll of the participant, otherwise the amount of money will be considered to be lost. As long as the bankroll had not reached zero, the participant was free to decide whether to continue the game or stop the game to cash the bankroll. The amount of bankroll, wager and the chosen option in every trial was logged for the analyses of the prior outcome and risk preference. The results showed that the participant's risk preference increased with the absolute value of preceding outcome, no matter it was a gain or a loss. Moreover, after a preceding win, the wager devoted into next trial was smaller than the profit of the last trial, which was consistent with the 'house money effect'. After a preceding loss, the potential profit in the next trial was larger than the loss of the last trial, which was consistent with the 'break even effect'. The present study suggests that when the decision task is repetitive and flexible, the strategy of the decision maker would be to avoid loss after the combination of previous profit (or loss) and the potential loss (or profit). The decision process in the presence of prior gain is as a kind of 'squander', with 'no loss' as the bottom line. Whereas in the presence of prior loss, the decision could be seen as a kind of 'fighting' which aims at 'no loss'. These results could be inspiring in predicting the way people react in risk decision. The main effort of subsequent study would be the probing into scenarios which would be more ecological and representative, such as decision in the stock market. (PsycINFO Database Record (c) 2016 APA, all rights reserved)