Disposition Effect Flashcards
What is the Disposition effect?
The tendency to sell assets that have gained value (winners) and hold onto assets that have lost value (losers)
Through what channels is the disposition effect explained?
1) Prospect Theory and the Value function
2) Mental Accounting
3) Regret Aversion
4) Self-control
What is regret Aversion?
Investors are reluctant to accept and realise losses, as it proves their first judgement was wrong
What is Mental Accounting?
Investors hold mental accounts of their funds, by “transferring assets” rather than “accepting a loss” the investors “mental account” isn’t closed but maintained.
What is self-control?
Investors ride their losses to postpone regret and sell winners too quickly to hasten their boost in pride.
What did Odean (1998) find?
1) Investors hold onto losers for a median of 124 days, winners 104 days
2) Investors realise 24% of their gains but only 15% of their losses,
3) Unsold losers return 5% the following year whilst winners 11.6% (ruling out rational explanations)
4) No brokerage pressure
5) Huge significance in disposition variables across a large sample size of individual investors
How might holding onto losers be considered rational?
1) Selling appreciated stocks to maintain diversification levels
2) Selling based on the rationale that the price now reflects new information/hold on believing price has yet to reflect information
3) Losing an investment tends to be related to a low-valued stock, so high trading costs might put off the investor from selling
What did Weber and Camerer (1998) find?
Stock prices are positively correlated over time - no mean-reversion yet there is still a disposition effect.
What is Dar and Zhu (2004) find?
On an individual level, wealthier individuals and professionals showed lower prevalence of disposition effect and a lower magnitude of the effect.
What is the relationship between disposition and momentum?
Grinblatt and Han (2005) found that investors over sell winners, putting downward pressure on their price, thus are undervalued. Vice versa for losers. Overtime if these stocks return to their true value, we will observe momentum.
