Tuesday, 24 February 2009

Realisation Utility

Professors Nicholas Barberis and Wei Xiong of Yale and Princeton Universities coined the term "realisation utility" when explaining investor behaviour. Realisation utility encourages investors to hang on to stocks that have sunk -- even when those stocks have dim futures. Here's what they wrote:

"The authors consider an additional experimental condition in which the experimenter liquidates subjects' holdings and then tells them that they are free to reinvest the proceeds in any way they like. If subjects were holding on to their losing stocks because they thought that these stocks would rebound, we would expect them to re-establish their positions in these losing stocks. In fact, subjects do not re-establish these positions."

"Subjects were refusing to sell their losers simply because it would have been painful to do so … subjects were relieved when the experimenter intervened and did it for them."

This is akin to the psychological pain of admitting you were wrong and instead sticking it out instead of changing. It may be a significant factor in politics.
Interactive Democracy can unlock politicians from "unprofitable" behaviour that they may be reluctant to relinquish themselves.
But will the majority get locked into poor behaviour? Will they exhibit "realisation utility"?
Individual voters are under far less pressure than politicians and this may allow them to change their view more easily, allowing timely changes of policy.

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