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Behavioral and Prescriptive Explanations of a Reverse Sunk Cost Effect

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Abstract

The all too common sunk cost effect is apparent when an investor influenced by what has been spent already persists in a venture, committing further resources or foregoing more profitable opportunities, when the economically rational action is to quit. Less common but arguably just as much a sunk cost effect is the mistake of giving up on a failed or failing venture too readily, sometimes out of nothing but pique at what has been lost, or perhaps through the more subtle psychological forces posited by Kahneman, Tversky, Thaler and others within prospect theory and related work on ``mental budgeting''. Two case examples are considered, wherein decision makers dissatisfied with the results of their investments, and having lost money, appear to compound their losses by selling out at prices less than their own estimates of the remaining financial worth of the failed assets. These decisions are evaluated from the perspectives of both behavioral and prescriptive economics, and are found to have possible explanations in both. Their prescriptive rationale assumes a portfolio theory of investment decisions, and is demonstrated within both expected utility (economics) and mean-variance (finance) frameworks.

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  1. Department of Accounting & Finance, University of Wollongong, NSW, 2522, Australia

    David Johnstone

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Johnstone, D. Behavioral and Prescriptive Explanations of a Reverse Sunk Cost Effect. Theory and Decision 53, 209–242 (2002). https://doi.org/10.1023/A:1022841432562

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