Contrast Effects in Investment and Financing Decisions

Jae Hyoung Kim and Elizabeth Hoffman

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: Contrast effects, a bias caused by a prior stimulus, has not been extensively studied in a financial context. This study develops an experimental design to examine whether contrast effects distort the risk attitudes of individuals under a choice-based elicitation procedure. We find that individuals exposed to a positive stimulus amplify risk-seeking in investment decisions as opposed to individuals exposed to a negative stimulus. However, individuals behave similarly in making financing decisions regardless of different economic stimuli, which could suggest that financing decisions require a high cognitive load. On average, individuals spent 4% more time and changed their answers 4% more often in making financing decisions than investment decisions. The results suggest financing decisions may require a higher mental effort, and provide robust evidence that contrast effects can lead to mistakes in investment decisions.

Date: 2018-09-01
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Persistent link: https://EconPapers.repec.org/RePEc:isu:genstf:201809010700001093

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