Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility

Cary Frydman, Nicholas Barberis, Colin Camerer, Peter Bossaerts, Antonio Rangel

NBER Working Paper No. 18562
Issued in November 2012
NBER Program(s):Asset Pricing

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.

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Document Object Identifier (DOI): 10.3386/w18562

Published: Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility CARY FRYDMAN, NICHOLAS BARBERIS, COLIN CAMERER, PETER BOSSAERTS andANTONIO RANGEL† Article first published online: 17 MAR 2014 DOI: 10.1111/jofi.12126 © 2014 the American Finance Association Issue The Journal of Finance The Journal of Finance Volume 69, Issue 2, pages 907–946, April 2014

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