Question

Explain 1) the concept of house money, 2) why the house money concept is such a common behavior for so many individuals and 3) why house money is an irrational behavior.

Answer 1

1: House money effect is the tendency of investors to take on greater risk at the time of reinvesting their earnings from financial instruments rather than at the time of investing their earnings.

2: The house money effect is common since the investors tend to take on greater risk after making profits in their initial trades. This is due to greater confidence in profitable dealings.

3: It is an irrational behavior because it is not necessary that the succeeding trades will also be profitable. It is possible that the latter trades may turn out to be unprofitable and may result in losses.