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What Drives the Disposition Effect? An Analysis of a Long-Standing Preference-Based Explanation

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  • NICHOLAS BARBERIS
  • WEI XIONG

Abstract

We investigate whether prospect theory preferences can predict a disposition effect. We consider two implementations of prospect theory: in one case, preferences are defined over "annual" gains and losses; in the other, they are defined over "realized" gains and losses. Surprisingly, the annual gain/loss model often fails to predict a disposition effect. The realized gain/loss model, however, predicts a disposition effect more reliably. Utility from realized gains and losses may therefore be a useful way of thinking about certain aspects of individual investor trading. Copyright (c) 2009 the American Finance Association.

Suggested Citation

  • 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, vol. 64(2), pages 751-784, April.
  • Handle: RePEc:bla:jfinan:v:64:y:2009:i:2:p:751-784
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    References listed on IDEAS

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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