Working Paper: NBER ID: w18562
Authors: Cary Frydman; Nicholas Barberis; Colin Camerer; Peter Bossaerts; Antonio Rangel
Abstract: We use measures of neural activity provided by functional magnetic resonance imaging (fMRI) to test the "realization utility" theory of investor behavior, which posits that people derive utility directly from the act of realizing gains and losses. Subjects traded stocks in an experimental market while we measured their brain activity. We find that all subjects exhibit a strong disposition effect in their trading, even though it is suboptimal. Consistent with the realization utility explanation for this behavior, we find that activity in the ventromedial prefrontal cortex, an area known to encode the value of options during choices, correlates with the capital gains of potential trades; that the neural measures of realization utility correlate across subjects with their individual tendency to exhibit a disposition effect; and that activity in the ventral striatum, an area known to encode information about changes in the present value of experienced utility, exhibits a positive response when subjects realize capital gains. These results provide support for the realization utility model and, more generally, demonstrate how neural data can be helpful in testing models of investor behavior.
Keywords: neural data; investor behavior; realization utility; fMRI; disposition effect
JEL Codes: G02; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| neural activity in the VMPFC (D87) | capital gains realized during stock trades (G10) |
| strength of the disposition effect (G41) | strength of the realization utility signal in the VMPFC (D87) |
| realizing a capital gain (G11) | activity in the VST (Y20) |
| realizing a capital loss (G32) | activity in the VST (Y20) |