Mental Accounting and False Reference Points in Real Estate Investment Decisions by Seiler, Lane, and Seiler.
"We find a statistically significant degree of mental accounting at all points throughout the disposition effect curve when holding a real estate investment in isolation versus holding the asset as part of a mixed-asset portfolio. We also identify four distinct disposition curve shapes beyond the traditional “S-shaped” curve where investors are more willing to sell an asset that is in the gains domain. Further, we conclude that an investor’s willingness to sell jumps by the greatest amount when going from zero return into profitable territory. Finally, this false reference point does take into consideration transaction costs."From the paper:
"If people were rational utility-maximizers, the decision to sell an asset would be independent of the price that was paid for the asset. The price paid in the past is a sunk cost, and should therefore be irrelevant to future buy/sell/hold decisions."
This would suggest a S-shaped function where people would be less willing to sell at a loss and more willing to sell at a gain. This is what they found most of the time. However they also found some exceptions: people who would sell major losers and major winners, but were reluctant to sell in the middle (the so-called U shaped curve).
"... the “S-shaped” disposition curve does not hold for all investors. Specifically, 7.3% of the sample possesses a “U-shaped” curve. This means that their willingness to sell is higher or lower around their break-even point when compared to extreme gains and losses."
The behavioral findings are very strong, but there are at least some "rational" people, but not many. The authors find
".... only 6.8% (36/533) of the sample exhibits complete rationality. In support of the extent literature, 74.9% (399/533) of the sample are more willing to sell as the return on the investment increases.Good stuff that will definitely make it to the classroom!
Cite: Seiler, Vicky L., Lane, Mark and Seiler, Michael Joseph, Mental Accounting and False Reference Points in Real Estate Investment Decision-Making (June 15, 2010). Available at SSRN: http://ssrn.com/abstract=1625407