Risk-Taking Behavior during Downturn: Evidence of Loss-Chasing and Realization Effect in the Cryptocurrency Market

Psychologists and economists have both explored how past outcomes influence subsequent risktaking behavior. However, psychologists traditionally focused on gambling, while economists mainly looked at investors’ decisions under uncertainty. As a result, the two fields arrived at different conclusions. Psychology literature identified loss-chasing behavior among casino gamblers and labeled it “compulsive gambling,” a disorder requiring treatment. Economists, on the other hand, introduced a concept of the “realization effect,” suggesting that risk-taking may increase after an unrealized loss but decrease after a realized loss (Imas, 2016). This paper aims to reconcile these two perspectives using empirical evidence from the cryptocurrency market, where gamblers and investors coexist. We find that high-risk individuals increase risk-taking after both unrealized and realized losses. In the most severe case, a one-standard-deviation increase in loss would raise risk-taking, as measured by portfolio volatility, by 58.72%. Thus, high-risk individuals in the cryptocurrency market behave like casino gamblers observed in Psychology literature. On the other hand, low-risk individuals increase risk-taking only after unrealized losses and avoid risks after realized losses. Thus, low-risk individuals in the cryptocurrency market behave like investors facing risky choices, which can be explained by the “realization effect” in Economics literature.