Recent empirical studies have documented a number of regularities in the behavior of investors that seem to be at odds with the rational expectations paradigm. One of the most striking patterns is the tendency of investors to sell their winners and to hold on to their losers. Such behavior, which has been termed the “disposition effect” by Shefrin and Statman (1985), has been found in a variety of data sets and time periods.
Although the existence of the disposition effect seems undisputed, economists and investment professionals have not agreed on an explanation for this phenomenon. The empirical literature favors a behavioral explanation offered by Shefrin and Statman (1985), which combines the ideas of mental accounting (Thaler (1985)) and prospect theory (Kahneman and Tversky (1979)). Shefrin and Statman argue that investors keep a separate mental account for each stock. Within that account, investors maximize an “S”-shaped valuation function, which is similar to a standard utility function except that it is defined on gains and losses relative to a reference point (usually the purchase price), rather than on absolute wealth. This valuation function is concave in the gains region and convex in the loss region. Thus, if a stock appreciates in price, the investor’s wealth will be in a more risk-averse part of her valuation function, making a sale more likely. In contrast, if the stock is trading below its purchase price, the investor becomes risk-loving, and will hold on to the stock for a chance to break even.
Following the basic results of tax competition literature, capital taxation is negatively and labour taxation is positively related to the degree of international capital mobility. Further-more, theory suggests that larger countries levy higher tax rates than smaller countries because the erosion of their tax base is smaller in per capita terms (cf. Bucovetsky 1991 and Wilson 1991). In full accordance with microeconomic principles, these predictions are derived from general equilibrium models. It is thus very surprising that most of recent empirical studies obtain almost reverse results.
Economic theory has formalized the notion that monetary trade may benefit society. In the presence of frictions, money can expand allocations by facilitating spot trade. A key element is difficulties in carrying out intertemporal trades, originating from society’s incapacity to enforce contracts, agents’ inability to commit to future actions, and unobservability of trading histories (Kocherlakota, 1998).
Recent work has relaxed some of these assumptions to study how the availability of credit affects allocations and the role of money. Despite the different approaches adopted, a common feature exists: default is either ignored or inconsistent with equilibrium.
