How Risk Attitudes are Affected by Paper and Realised Outcomes in Skill-Influenced Versus Pure-Luck Settings

How do investors and gamblers respond after incurring losses? Do they cut their losses and take more cautious actions, or do they take on additional risk in an attempt to break even? Recent research suggests that the answer depends on whether these losses are perceived as "paper" or "realised" outcomes (Flepp et al. 2021; Imas 2016).

Within the framework of prospect theory (Tversky and Kahneman 1992), paper losses, such as those from holding a depreciating stock, tend to increase risk-taking, known as loss-chasing. In contrast, realised losses, such as those after the stock is sold, tend to heighten caution (Barberis et al. 2001). Imas (2016) produces experimental evidence that a transfer of funds out of a gambling account is sufficient to trigger this shift towards more cautious behaviour, which he terms the "realisation effect".

My thesis seeks to deepen our understanding of the realisation effect, testing the hypothesis that breaks in risk-taking activities trigger the realisation of prior outcomes. To achieve this, I will employ controlled laboratory experiments, where I introduce breaks in gambling decision-tasks as an exogenous treatment, allowing me to causally verify that breaks trigger realisation of outcomes.

By varying the length and nature of breaks, the study will provide evidence on how different interruptions mitigate the loss-chasing behaviour associated with paper losses.

Complementing the laboratory analysis is a field study of online gambling. Using a large panel dataset of online poker hands punctuated by various breaks in play, I will examine whether the findings from the laboratory study are consistent with the behaviour exhibited by professional and amateur gamblers in a high-stakes environment.

Additionally, I investigate behaviour following recent gains. Some studies report increased risk-taking after paper gains, known as the "house-money" effect (Thaler and Johnson 1990), while others observe post-gain caution, a "lock-in-the-win" effect (Eil and Lien 2014). I

propose that these contradictory findings can be explained by whether prior gains are attributed to luck or skill. Through further experiments manipulating the perception of skill versus luck, I will test the hypothesis that the attribution of gains to skill leads to more cautious post-gain behaviour. This can be understood within Barberis and Xiong's (2012) "realisation utility" framework if the utility of securing a win is enhanced by pride in one's decisions.

Realising losses mitigates loss-chasing behaviour, which is associated with problem gambling and also exhibited by professional risk-takers (Eil and Lien 2014, Smith et al. 2009). Thus, the findings from this research will offer valuable insights for gambling management and regulation. By providing empirical evidence on realisation triggers, this study will inform the development of interventions, such as stop-loss limits and mandatory breaks in play, to safeguard online gamblers.

Additionally, the insights gained on behaviour after gains and losses can help foster healthier risk-taking practices in various professional contexts.