Blackwell Reference Online

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The house money effect, proposed to describe the effect of prior outcomes on risky choice, was introduced to finance by Thaler and Johnson (1990) . Agents that are subject to the house money effect are inclined to take larger risks when prior outcomes have been positive. The house money effect is an example of mental accounting, in which agents mentally keep quantities of money in artificially separate “accounts.” Agents that exhibit the house money effect consider large or unexpected wealth gains to be distinct from the rest of their wealth, and are thus more willing to gamble with such gains than they ordinarily would be. Thaler and Johnson argue that the house money effect is consistent with prospect theory ( Kahneman and Tversky, 1979 ) if agents apply “hedonic editing” to the gambles they face. Barberis, Huang, and Santos (2001) use the house money effect, along with first order risk aversion, to explain the high volatility of asset prices and the equity premium puzzle. ( 2001 ). Prospect theory and asset prices . Quarterly Journal of Economics , 116 , 1 – 53 . ( 1979 ). Prospect theory: An analysis of decision under risk . Econometrica , 47 , 263 – 91 . ( 1990 ). Gambling with the house money and trying to break even: The effects of prior outcomes on risky choice . Management Science , 36 , 643 – 60 . ... log in or subscribe to read full text