Contrast Effects in Investment and Financing Decisions

The effects of prior positive or negative stimuli (contrast effects) have 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. We find that, on average, individuals spend 16% more time making financing decisions than investment decisions. The results provide robust evidence that contrast effects can lead to mistakes in investment decisions and suggest that financing decisions may require more mental effort than investment decisions.