Let’s call it quits: break-even effects in the decision to stop taking risks

Abstract

'Chasing' behavior, whereby individuals, driven by a desire to break-even, continue a risky activity (RA) despite incurring large losses, is a commonly observed phenomenon. We examine whether the desire to break-even plays a wider role in decisions to stop engaging in financially motivated RA in a naturalistic setting. We test hypotheses, motivated by this research question, using a large dataset: 707,152 transactions of 5,379 individual financial market spread traders between September 2004 and April 2013. The results indicate strong effects of changes in wealth around the break-even point on the decision to cease a RA. An important mediating factor was the individual's historical long-term performance. Those with a more profitable trading history were less affected by a fall in cash-balance below the break-even point compared to those who had been less profitable. We observe that break-even points play an important role in the decision of non-pathological risk-takers to stop RAs. It is possible, therefore, that these non-pathological cognitive processes, when occurring in extrema, may result in pathological gambling behavior such as ‘chasing’. Our dataset focuses on RAs in financial markets and, consequently, we discuss the implications for institutions and regulators in the effective management of risk taking in markets. We also suggest that there may be a need to consider carefully the nature and role of ‘break-even points’ associated with a broader range of non-financially-focussed risk taking activities, such as smoking and substance abuse.

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