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Behavioral Biases and Investment

  • Massimo Massa
  • Andrei Simonov

We investigate the way investors react to prior gains/losses. We directly examine investor reactions to different definitions of gains and losses (i.e., overall wealth, paper gains and losses, and realized capital gains and losses) and investigate how gains and losses in one category of wealth (e.g., real estate) affect holdings in other categories (e.g., financial assets). We show that investors change their holdings of risky assets as a function of both financial and real estate gains. Prior gains increase risk-taking, while prior losses reduce it. To interpret our results, we consider and compare three alternative hypotheses of investor behavior: prospect theory, house money effect and standard utility theory with decreasing risk aversion. Our evidence fails to support loss aversion, pointing in the direction of the house money effect or standard utility theory. Investors consider wealth in its entirety, and risk-taking in financial markets is affected by gains/losses in overall wealth, financial wealth, and real estate wealth. Copyright Springer 2005

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File URL: http://hdl.handle.net/10.1007/s10679-005-4998-y
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Article provided by Springer in its journal Review of Finance.

Volume (Year): 9 (2005)
Issue (Month): 4 (December)
Pages: 483-507

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Handle: RePEc:kap:eurfin:v:9:y:2005:i:4:p:483-507
Contact details of provider: Web page: http://springerlink.metapress.com/link.asp?id=111870

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  1. Edin, P.-A. & Fredriksson, P., 2000. "LINDA - Longitudinal INdividual DAta for Sweden," Papers 2000-19, Uppsala - Working Paper Series.
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