One of the most significant and unique features in Kahneman and Tversky's approach to choice under uncertainty is aversion to loss realization. This paper is concerned with two aspects of this feature. First, we place this behavior pattern into a wider theoretical framework concerning a general disposition to sell winners too early and hold losers too long. This framework includes other elements, namely mental accounting, regret aversion, self-control, and tax considerations. Second, we discuss evidence which suggests that tax considerations alone cannot explain the observed patterns of loss and gain realization, and that the patterns are consistent with a combined effect of tax considerations and the three other elements of our framework. We also show that the concentration of loss realizations in December is not consistent with fully rational behavior, but is consistent with our theory. IT HAS BEEN WELL-KNOWN for over thirty years that individual decision makers do not behave in accordance with the axioms of expected utility theory. The famous Allais paradoxes [1] have made this point abundantly clear. Recent work by Kahneman and Tversky [15], Machina [19], and others has sought to provide a theory which describes how decision makers actually behave when confronted with choice under uncertainty. One of the key findings by Kahneman and Tversky concerns decision makers whose recent gambling history reflects losses. They indicate that their analysis suggests that a person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise (p. 287).Kahneman and Tversky's finding was obtained in a controlled experimental situation. Economists tend to treat experimental evidence with some caution and are reluctant to conclude automatically that similar features will be exhibited in real-world market settings. Indeed, it is important to look at market behavior in order to ascertain whether such behavior patterns can be discerned in actual trading.In this paper, we examine decisions to realize gains and losses in a market setting. Specifically, we focus attention on financial markets and seek to determine whether investors exhibit a reluctance to realize losses (disposition to "ride * University of Santa Clara, Leavey School of Business. We would like to acknowledge the helpful remarks made on earlier versions by

One of the most significant and unique features in Kahneman and Tversky's approach to choice under uncertainty is aversion to loss realization. This paper is concerned with two aspects of this feature. First, we place this behavior pattern into a wider theoretical framework concerning a general disposition to sell winners too early and hold losers too long. This framework includes other elements, namely mental accounting, regret aversion, self‐control, and tax considerations. Second, we discuss evidence which suggests that tax considerations alone cannot explain the observed patterns of loss and gain realization, and that the patterns are consistent with a combined effect of tax considerations and the three other elements of our framework. We also show that the concentration of loss realizations in December is not consistent with fully rational behavior, but is consistent with our theory.

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We develop a positive behavioral portfolio theory (BPT) and explore its implications for portfolio construction and security design. The optimal portfolios of BPT investors resemble combinations of bonds and lottery tickets, consistent with Friedman and Savage's (1948) observation. We compare the BPT efficient frontier with the mean-variance efficient frontier and show that, in general, the two frontiers do not coincide. Optimal BPT portfolios are also different from optimal CAPM portfolios. In particular, the CAPM twofund separation does not hold in BPT. We present BPT in a single mental account version (BPT-SA) and a multiple mental account version (BPT-MA). BPT-SA investors integrate their portfolios into a single mental account, while BPT-MA investors segregate their port? folios into several mental accounts. BPT-MA portfolios resemble layered pyramids, where layers are associated with aspirations. We explore a two-layer portfolio where the low aspiration layer is designed to avoid poverty while the high aspiration layer is designed for a shot at riches. I.