House Money: All Of The Thrill With None Of The Stress

Spending free money can be fun, whether it be from winnings or when accessing a government stimulus package.

A day at the races

Picture the scene. Two friends go to the horse races. Neither is a particular horse racing fan with special knowledge when it comes to betting on the horses. It’s a fun day out.

It comes to the last race of the day. The first person has had a successful day. She’s won €100. To her, this is a reasonable sum. Come the last race, she has the opportunity to bet again or take the winnings and go home. For the sheer fun of it, she decides to take the €100 and place it on the favourite. At short odds of 1/5, she stands to win €20 at the risk of losing the €100 she’s already up. Easy come, easy go!

Her friend has been less fortunate. She’s down €100, which is also a reasonable sum to her. Come the last race, she can decide to call it quits or bet again. She decides to bet in an attempt to make up her losses. To do this she puts €20 on an outsider with long odds of 5-1 in the hope of making up her losses. Better a lion than a lamb.

Until the result of the last race is announced, no one knows what the finances of the two friends will look like. But even before the last race is run, it is clear that the two friends are making very different decisions by the end of the day.

The house money and break-even effects

The first friend is in a fortunate position. Because of her previous luck, she can take a low risk bet and still end the day square.

The second friend is less fortunate. She is under stress. Losing €100 may mean having to cancel some fun nights out planned for the next two weeks. She takes a high-risk gamble.

This difference in behaviour demonstrated in the example of the two friends provided the basis of a 1990 article by Richard Thaler and Eric Johnson titled “Gambling with the House Money and Trying to Break Even: The Effects of Past Outcomes on Risky Choices”. 

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