The House Money Effect: Explanation Based On Reference Point Adoption And The Psychology Of Windfall Gains

Loss aversion is one of the basic characteristics of decision making behavior.Kahneman and Tversky suggested people would typically reject gambles which offer a50/50chance of gaining or losing the same amounts of money because losses mightgenerate bigger psychological utility than equivalent gains. Previous studies documentedthat loss aversion was a wide spread and robust phenomenon, and not only for money, butalso for chocolates, lottery tickets, buildings and other items. However, sometimes, theprinciple of loss aversion cannot explain some phenomena. For example, you probablymay reject a gamble game showing a50/50chance of gaining or losing$100since lossaversion, but if you are told that you have played once and wan$100, whether do youwant to bet at this time? Previous studies reported that under some circumstance a priorgain could increase people’s willingness to accept risky gambles. Some scholars namedthis phenomenon that prior gains may increase people’s willingness to accept risky gambles as the sunk gains or the house money effect. Many studies have shown that thehouse money effect is a robust phenomenon but few scholars explain the mechanism of itwell.At present, the most authentic interpretation of the house money effect is made byRichard Thaler and Eric Johnson, professors of Chicago University based on the theory ofmental accounting and its special editing rules: People tend to segregate gains andintegrate later losses with the prior gains (if later losses were no bigger than prior gains).Then the competition between the eager to―win another￥100‖and the fear of―the gainsdecrease from￥100to zero‖decides whether participants will continue to bet or not. Thepsychological value of win and loss is the same. Thaler and Johnson published their articleGambling with the house money and trying to break even: The effects of prior outcomes onrisky choice in1990expressing their theory comprehensively. Until now, their article hasbeen cited by more than1300times and is regarded as the most important literature ofbehavioral decision making study.However, based on our analysis, there are also a series of contradiction in theexplanation suggested by Thaler and Johnson. For example, they neglected to analyze andexamined the law of reference fluctuation in sequent decision making and they also failedto test and verify whether people comprehend the results of sequent decisions according tothe editing rules.We suppose the reason for the house money effect is that if the ante is from the priorgambling profits, and its potential loss costs relatively low psychological value. Forproving the hypothesis, we designed a series of sub-studies based on the experimentalparadigm of two-stage gambles, and totally993university students as participantsinvolving in the research. The main results of this research are as follows:1. Study1aimed to test the validity of the explanation of editing rules to the housemoney effect. We tested how people responded to―prospect theory, with memory‖frame,―concreteness‖frame and―quasi-hedonic‖editing. The results indicated that none of thesetypes of frames resulted in a significant house money effect. The result of study1to someextend denied the explanation suggested by Thaler and Johnson. 2. Study2tried to discuss whether the reference point was in the original or currentstate. The results revealed that there was a reference adoption when winning, in otherwords, the reference point shifted to￥100in the second-stage gamble. People tended tounderstand the loss in the second stage gamble as―loss the prior gained￥100‖ratherthan―the gains decrease from￥100to0‖derived by Thaler and Johnson. People tendedto comprehend the win in the second stage gamble as―win another￥100‖rather than―then gains increase from￥100to￥200‖. The results of study2were published inSocial Indicator Research, an SSCI journal.3. In study3, we using3experiments together prove that gambling profits and norma lincome will open different mental accounts. Experiment1documented that the pain oflosing￥100allowance was more serious than that of losing￥100gambling wins.Experiment2demonstrated that compared with normal income, people were more willingto spend gambling gains on luxury consumption. Experiment3proved people wouldtypically reject the gamble of50/50chance to gain or lose￥100if the ante is from the normal income account’, but accept if the ante is from the windfall account’. The resultsof the series of experiments proved the accuracy of our hypothesis mostly and werepublished in the leading journal of behavioral decision making, Judgment and DecisionMaking.4. In study4, we directly tested the prediction ability of the cognition of results of thesecond-stage gamble to decision making, and the regression equation was significant. Wehave submitted the result of this part to the Journal of Behavioral Decision Making.The conclusions of this research are as follows:1. The house money effect is a robust phenomenon that prior gains may significantlyincrease people’s willingness to accept risky gambles;2. In winning in the first-stage gamble, there is a reference point shift whe nconsidering whether to participate in the second stage gamble. The house money effect canbe regarded as a violation of loss aversion.3. People may regard gambling earnings as windfall gains with lower psychologica lvalve than normal incomes. Its potential loss will not hurt that much, which is the real mechanism of the house money effect.4. The understanding of sequent decision making results to some extent determineswhich variable option the decision maker will take.There are some theoretical contribution and innovation in the current study. Firstly,we oppugn the authentic interpretation of house money effect, and give a new explanationcombined with the theory of reference point adoption and the psychology of windfall gains.The exploration of the law of reference fluctuation and the slope change of value curve insequent decision making provides a way to expand the use of Prospect theory from singleto sequent decision making. Secondly, we firstly distinguish the two different cognitiveprocesses of understandings the current gamble stage result and the final gamble result, inaddition, only the comprehension of the current stage result can significantly predict whichchoice the decision makers will make.