What Drives the Disposition Effect? An Analysis of a Long‐Standing Preference‐Based Explanation
- Author(s): NICHOLAS BARBERIS, WEI XIONG
- Published: Mar 13, 2009
- Pages: 751-784
- DOI: 10.1111/j.1540-6261.2009.01448.x
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.