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.
D81, G02, G11, G30
Original Release Date: September 2018
Department of Economics, Iowa State University
Kim, Jae Hyoung and Hoffman, Elizabeth, "Contrast Effects in Investment and Financing Decisions" (2018). Economics Working Papers: Department of Economics, Iowa State University. 18024.