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Realization Utility

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  • Nicholas C. Barberis
  • Wei Xiong

Abstract

A number of authors have suggested that investors derive utility from realizing gains and losses on assets that they own. We present a model of this “realization utility,” analyze its predictions, and show that it can shed light on a number of puzzling facts. These include the disposition effect, the poor trading performance of individual investors, the higher volume of trade in rising markets, the effect of historical highs on the propensity to sell, the individual investor preference for volatile stocks, the low average return of volatile stocks, and the heavy trading associated with highly valued assets.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14440.

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Date of creation: Oct 2008
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Publication status: published as Barberis, Nicholas & Xiong, Wei, 2012. "Realization utility," Journal of Financial Economics, Elsevier, vol. 104(2), pages 251-271.
Handle: RePEc:nbr:nberwo:14440

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  1. Nicholas Barberis, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 56(4), pages 1247-1292, 08.
  2. Nicholas Barberis & Wei Xiong, 2009. "What Drives the Disposition Effect? An Analysis of a Long-Standing Preference-Based Explanation," Journal of Finance, American Finance Association, American Finance Association, vol. 64(2), pages 751-784, 04.
  3. Jeremy C. Stein, 1993. "Prices and Trading Volume in the Housing Market: A Model with Downpayment Effects," NBER Working Papers 4373, National Bureau of Economic Research, Inc.
  4. Brad M. Barber & Terrance Odean, 2000. "Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors," Journal of Finance, American Finance Association, American Finance Association, vol. 55(2), pages 773-806, 04.
  5. David Genesove & Christopher Mayer, . "Loss Aversion and Seller Behavior: Evidence from the Housing Market," Zell/Lurie Center Working Papers, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania 323, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania.
  6. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, Econometric Society, vol. 47(2), pages 263-91, March.
  7. Andrea Frazzini, 2006. "The Disposition Effect and Underreaction to News," Journal of Finance, American Finance Association, American Finance Association, vol. 61(4), pages 2017-2046, 08.
  8. Malcolm Baker & Jeffrey Wurgler, 2007. "Investor Sentiment in the Stock Market," NBER Working Papers 13189, National Bureau of Economic Research, Inc.
  9. Mark Grinblatt, 2001. "What Makes Investors Trade?," Journal of Finance, American Finance Association, American Finance Association, vol. 56(2), pages 589-616, 04.
  10. Malcolm Baker & Xin Pan & Jeffrey Wurgler, 2009. "A Reference Point Theory of Mergers and Acquisitions," NBER Working Papers 15551, National Bureau of Economic Research, Inc.
  11. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, American Finance Association, vol. 53(5), pages 1775-1798, October.
  12. Nicholas Barberis & Ming Huang, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," NBER Working Papers 8190, National Bureau of Economic Research, Inc.
  13. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 61(1), pages 259-299, 02.
  14. Hong, Harrison & Stein, Jeremy, 2007. "Disagreement and the Stock Market," Scholarly Articles 2894690, Harvard University Department of Economics.
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  16. Weber, Martin & Camerer, Colin F., 1998. "The disposition effect in securities trading: an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 33(2), pages 167-184, January.
  17. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(1), pages 1-53, February.
  18. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, American Economic Association, vol. 89(5), pages 1279-1298, December.
  19. Grinblatt, Mark & Han, Bing, 2005. "Prospect theory, mental accounting, and momentum," Journal of Financial Economics, Elsevier, Elsevier, vol. 78(2), pages 311-339, November.
  20. Mark Grinblatt & Matti Keloharju, 2006. "Sensation Seeking, Overconfidence, and Trading Activity," NBER Working Papers 12223, National Bureau of Economic Research, Inc.
  21. Shefrin, Hersh & Statman, Meir, 1985. " The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, American Finance Association, vol. 40(3), pages 777-90, July.
  22. Kaustia, Markku, 2010. "Prospect Theory and the Disposition Effect," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 45(03), pages 791-812, June.
  23. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  24. Alok Kumar, 2009. "Who Gambles in the Stock Market?," Journal of Finance, American Finance Association, American Finance Association, vol. 64(4), pages 1889-1933, 08.
  25. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 60, pages 151.
  26. Ravi Dhar & Ning Zhu, 2006. "Up Close and Personal: Investor Sophistication and the Disposition Effect," Management Science, INFORMS, INFORMS, vol. 52(5), pages 726-740, May.
  27. Meir Statman & Steven Thorley & Keith Vorkink, 2006. "Investor Overconfidence and Trading Volume," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 19(4), pages 1531-1565.
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Citations

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Cited by:
  1. Summers, Barbara & Duxbury, Darren, 2012. "Decision-dependent emotions and behavioral anomalies," Organizational Behavior and Human Decision Processes, Elsevier, Elsevier, vol. 118(2), pages 226-238.
  2. Hsiaw, Alice, 2013. "Goal-setting and self-control," Journal of Economic Theory, Elsevier, Elsevier, vol. 148(2), pages 601-626.
  3. Urs Fischbacher & Gerson Hoffmann & Simeon Schudy, 2014. "The causal effect of stop-loss and take-gain orders on the disposition effect," TWI Research Paper Series, Thurgauer Wirtschaftsinstitut, Universität Konstanz 89, Thurgauer Wirtschaftsinstitut, Universität Konstanz.
  4. Nicholas C. Barberis, 2013. "Thirty Years of Prospect Theory in Economics: A Review and Assessment," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 27(1), pages 173-96, Winter.
  5. Li, Yan & Yang, Liyan, 2013. "Prospect theory, the disposition effect, and asset prices," Journal of Financial Economics, Elsevier, Elsevier, vol. 107(3), pages 715-739.
  6. Pereira Reichhardt, Joaquín & Iqbal, Tabassum, 2014. "Investment Decisions: Are we fully-Rational?," MPRA Paper 57686, University Library of Munich, Germany.
  7. Cao, Jie & Han, Bing, 2013. "Cross section of option returns and idiosyncratic stock volatility," Journal of Financial Economics, Elsevier, Elsevier, vol. 108(1), pages 231-249.
  8. Cary Frydman & Nicholas Barberis & Colin Camerer & Peter Bossaerts & Antonio Rangel, 2012. "Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility," NBER Working Papers 18562, National Bureau of Economic Research, Inc.
  9. Ben-David, Itzhak & Hirshleifer, David, 2011. "Beyond the Disposition Effect: Do Investors Really Like Gains More Than Losses?," Working Paper Series, Ohio State University, Charles A. Dice Center for Research in Financial Economics 2011-13, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  10. Kohsaka Youki & Grzegorz Mardyla & Shinji Takenaka & Yoshiro Tsutsui, 2013. "Disposition Effect and Diminishing Sensitivity: An Analysis Based on a Simulated Experimental Stock Market," Discussion Papers in Economics and Business 13-02-Rev.2, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP), revised Sep 2014.

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