FIN 260 Lecture Notes - Lecture 65: Mental Accounting, Larry Bird, Auction Theory

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Asymmetric Loss Aversion in Finance:
Disposition Effect:
o Pain of loss is greater than benefits of gain.
We take great risk to get rid of a loss.
We will get rid of risk when it comes to a winner.
o The same idea can be applied to stocks.
If a stock goes down (we hold on to it to get our money back).
If a stock goes up we sell it.
We hold onto losing stocks & sell winning stocks.
o We have predisposition to get back to even.
We sell winners.
Hold on to losers.
o This behavioral is bad for 2 reasons:
1. Taxes:
The stocks we sell we have to pay capital gains on.
2. Stocks have momentum:
Winning stocks tend to keep going up.
Losing stocks continue to go down.
Our performance is very poor as are selling winners & holding
losers.
Irrational Pricing:
o 55 students were asked to write down the last 2 digits of their social
security numbers. Then they were asked whether they would pay a
certain # in dollars for a certain bottles of wine & computer items. Finally,
they were asked what would they actually pay for these items.
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Document Summary

If a stock goes down (we hold on to it to get our money back). If a stock goes up we sell it. We hold onto losing stocks & sell winning stocks: we have predisposition to get back to even, we sell winners, hold on to losers, this behavioral is bad for 2 reasons, taxes: The stocks we sell we have to pay capital gains on: stocks have momentum: Winning stocks tend to keep going up. Our performance is very poor as are selling winners & holding losers. Irrational pricing: 55 students were asked to write down the last 2 digits of their social security numbers. Then they were asked whether they would pay a certain # in dollars for a certain bottles of wine & computer items. Finally, they were asked what would they actually pay for these items: students w/ highest ss#s bid the highest, those w/ lowest ss#s bid the lowest.

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