We show that investors trade as if they consider dividends and capital gains in separate mental accounts, without fully appreciating that dividends come at the expense of price decreases. Investors trade differently in response to each component – trading patterns such as the disposition effect are driven by price changes, with dividends being ignored or downweighted. Investors hold dividend-paying stocks longer, and are less sensitive to price changes, consistent with dividends being valued as a separate desirable attribute of stocks. The demand for dividend-paying stocks is higher when interest rates and recent market returns are lower, consistent with investors comparing dividends to other income streams and capital gains. Investors spend the proceeds of each component differently – mutual funds and institutions rarely reinvest dividends into the stocks from which they came, but instead purchase other stocks. This leads to predictable marketwide price increases on days of large aggregate dividend payouts, including stocks not paying dividends.
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