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

The Journal of Finance
Cary FrydmanAntonio 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.

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Citations

Sep 24, 2014·Current Biology : CB·Colin F Camerer
Mar 17, 2015·Journal of Economic Behavior & Organization·Cary Frydman, Antonio Rangel
Aug 9, 2016·Trends in Cognitive Sciences·Cary Frydman, Colin F Camerer
Jul 3, 2015·Scientific Reports·Carlos CuevaAldo Rustichini
Jan 8, 2016·Journal of Neurophysiology·Kainan S WangMauricio R Delgado
Oct 17, 2017·Frontiers in Neuroscience·GianMario RaggettiCinzia Di Dio

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