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Once Burned, Twice Shy: How Naïve Learning, Counterfactuals, and Regret Affect the Repurchase of Stocks Previously Sold

42 Pages Posted: 16 Sep 2005 Last revised: 7 Aug 2010

Terrance Odean

University of California, Berkeley - Haas School of Business

Michal Ann Strahilevitz

Victoria University

Brad M. Barber

University of California, Davis

Date Written: July 31, 2010

Abstract

We establish two previously undocumented patterns in the purchase selections of individual investors. These patterns hinge on investors’ previous experiences with a stock. We demonstrate that investors prefer to (1) repurchase stocks they previously sold for a gain rather than stocks they previously sold for a loss and (2) repurchase stocks that have lost value subsequent to a prior sale rather than those that have gained value. We document these trading patterns by analyzing trading records for 66,465 households at a large discount broker between January 1991 and November 1996, and 665,533 investors at a large retail broker between January 1997 and June 1999. We propose that the first trading pattern results from a simple form of learning whereby investors repeat actions that previously resulted in pleasure while avoiding actions that previously led to pain (i.e., they repurchase their previous winners more readily than their previous losers). We argue that the second trading pattern is tied to counterfactuals. Investors who buy a stock at a higher price than they previously sold it for are painfully aware that they are worse off than if they had simply never sold that stock. Investors who buy a stock at a lower price than they previously sold it experience the pleasure of knowing they are better off than if they had never sold that stock. Investor returns do not benefit from either of the two patterns we document.

Keywords: Behavioral finance, prospect theory, disposition effect, individual investors

JEL Classification: G11, D1

Suggested Citation

Odean, Terrance and Strahilevitz, Michal Ann and Barber, Brad M., Once Burned, Twice Shy: How Naïve Learning, Counterfactuals, and Regret Affect the Repurchase of Stocks Previously Sold (July 31, 2010). Available at SSRN: https://ssrn.com/abstract=611267 or http://dx.doi.org/10.2139/ssrn.611267

Terrance Odean (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-642-6767 (Phone)
510-666-2561 (Fax)

HOME PAGE: http://www.haas.berkeley.edu/faculty/odean.html

Michal Ann Strahilevitz

Victoria University ( email )

23 Lambton Quay
1100 Rutherford House
Wellington, 6011
New Zealand
(510) 594-9999 (Phone)

HOME PAGE: http://www.victoria.ac.nz/smib/about/staff/michal-strahilevitz

Brad M. Barber

University of California, Davis ( email )

Graduate School of Management
One Shields Avenue
Davis, CA 95616
United States
530-752-0512 (Phone)
530-752-2924 (Fax)

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