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Realization utility

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  • Barberis, Nicholas
  • Xiong, Wei

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.

Suggested Citation

  • Barberis, Nicholas & Xiong, Wei, 2012. "Realization utility," Journal of Financial Economics, Elsevier, vol. 104(2), pages 251-271.
  • Handle: RePEc:eee:jfinec:v:104:y:2012:i:2:p:251-271 DOI: 10.1016/j.jfineco.2011.10.005
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    References listed on IDEAS

    as
    1. 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.
    2. Harrison Hong & Jeremy C. Stein, 2007. "Disagreement and the Stock Market," Journal of Economic Perspectives, American Economic Association, pages 109-128.
    3. Shlomo Benartzi & Richard H. Thaler, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 73-92.
    4. Chip Heath & Steven Huddart & Mark Lang, 1999. "Psychological Factors and Stock Option Exercise," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 601-627.
    5. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    6. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    7. Meir Statman & Steven Thorley & Keith Vorkink, 2006. "Investor Overconfidence and Trading Volume," Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1531-1565.
    8. Mark Grinblatt & Matti Keloharju, 2009. "Sensation Seeking, Overconfidence, and Trading Activity," Journal of Finance, American Finance Association, vol. 64(2), pages 549-578, April.
    9. Jeremy C. Stein, 1995. "Prices and Trading Volume in the Housing Market: A Model with Down-Payment Effects," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 379-406.
    10. David Genesove & Christopher Mayer, 2001. "Loss Aversion and Seller Behavior: Evidence from the Housing Market," The Quarterly Journal of Economics, Oxford University Press, pages 1233-1260.
    11. Kaustia, Markku, 2010. "Prospect Theory and the Disposition Effect," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(03), pages 791-812, June.
    12. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, vol. 53(5), pages 1775-1798, October.
    13. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151-151.
    14. Nicholas Barberis, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," Journal of Finance, American Finance Association, vol. 56(4), pages 1247-1292, August.
    15. Malcolm Baker & Jeffrey Wurgler, 2007. "Investor Sentiment in the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 129-152, Spring.
    16. Andrea Frazzini, 2006. "The Disposition Effect and Underreaction to News," Journal of Finance, American Finance Association, vol. 61(4), pages 2017-2046, August.
    17. Mark Grinblatt, 2001. "What Makes Investors Trade?," Journal of Finance, American Finance Association, vol. 56(2), pages 589-616, April.
    18. 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, vol. 55(2), pages 773-806, April.
    19. Alok Kumar, 2009. "Who Gambles in the Stock Market?," Journal of Finance, American Finance Association, vol. 64(4), pages 1889-1933, August.
    20. Ravi Dhar & Ning Zhu, 2006. "Up Close and Personal: Investor Sophistication and the Disposition Effect," Management Science, INFORMS, vol. 52(5), pages 726-740, May.
    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, vol. 40(3), pages 777-790, July.
    22. Weber, Martin & Camerer, Colin F., 1998. "The disposition effect in securities trading: an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 167-184, January.
    23. Nicholas Barberis & Ming Huang, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," NBER Working Papers 8190, National Bureau of Economic Research, Inc.
    24. Grinblatt, Mark & Han, Bing, 2005. "Prospect theory, mental accounting, and momentum," Journal of Financial Economics, Elsevier, pages 311-339.
    25. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory and Asset Prices," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 1-53.
    26. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
    27. 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.
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    More about this item

    Keywords

    Behavioral finance; Disposition effect; Trading; Individual investors;

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • 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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