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Published on: September 19, 2012
Let's Call it Quits: Break-Even Effects in the Decision to Stop Taking Risks.
Peter A F Fraser-Mackenzie1, Tiejun Ma1, Ming-Chien Sung1
1Centre for Risk Research, Southampton Business School, University of Southampton, Southampton, UK.
Summary
Individuals continue risky financial activities due to a desire to break even, even after losses. Historical trading performance influences this "chasing" behavior, impacting decisions to stop risky activities (RA).
Area of Science:
- Behavioral Economics
- Financial Markets
- Decision Science
Background:
- The phenomenon of "chasing" behavior, where individuals persist in risky activities (RA) after losses due to a desire to break even, is widely observed.
- Understanding the factors influencing the cessation of financially motivated RA is crucial for market regulation and individual financial health.
Purpose of the Study:
- To investigate the role of the "break-even" point in decisions to stop engaging in financially motivated risky activities.
- To determine if wealth changes around the break-even point influence the cessation of RA in a naturalistic financial market setting.
Main Methods:
- Analysis of a large dataset comprising 707,152 transactions from 5,379 individual financial market spread traders.
- Longitudinal study covering transactions between September 2004 and April 2013.
Main Results:
- Significant impact of wealth changes around the break-even point on the decision to cease RA.
- Individual's historical long-term performance mediated the effect of falling below the break-even point; more profitable traders were less affected.
- Break-even points significantly influence nonpathological risk-takers' decisions to stop RAs.
Conclusions:
- Break-even points are a critical factor in the decision-making process for stopping risky financial activities.
- Nonpathological cognitive processes related to break-even points may contribute to pathological behaviors like "chasing" in gambling.
- Findings have implications for financial market regulation, risk management, and understanding broader risk-taking behaviors like substance abuse.
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