Portfolio Rebalancing with Realization Utility

50 Pages Posted: 30 Jan 2022 Last revised: 7 Mar 2022

See all articles by Min Dai

Min Dai

The Hong Kong Polytechnic University

Cong Qin

Soochow University

Neng Wang

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Multiple version iconThere are 2 versions of this paper

Date Written: January 29, 2022

Abstract

We develop a model where a realization-utility investor (Barberis and Xiong, 2009, 2012; Ingersoll and Jin, 2013) optimally targets her liquid-illiquid wealth ratio at a constant w∗. By saving in the risk-free asset (w∗ > 0), she makes smaller bets in the illiquid asset and realizes gains/losses more frequently. By leveraging (w∗ < 0), she makes bets larger than her equity and realizes gains/losses less frequently. For a discontinuous/jump-diffusion price process, the solution features four regions: loss-realization, gain-realization, and two disconnected (deep-loss and normal) holding regions. We generate a quantitatively significant non-monotonic propensity to realize losses consistent with evidence.

Keywords: prospect theory; loss aversion; option value; disposition effect

JEL Classification: D03, G11, G12

Suggested Citation

Dai, Min and Qin, Cong and Wang, Neng, Portfolio Rebalancing with Realization Utility (January 29, 2022). Columbia Business School Research Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=4021117 or http://dx.doi.org/10.2139/ssrn.4021117

Min Dai

The Hong Kong Polytechnic University ( email )

Cong Qin (Contact Author)

Soochow University ( email )

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Neng Wang

Columbia University - Columbia Business School, Finance ( email )

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National Bureau of Economic Research (NBER) ( email )

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