Week 5 - Chang, T., Solomon, D. and Westerfield, M. (2016). Looking for someone to blame: Delegation, cognitive dissonance, and the disposition effect.

Question 1

What is the main idea of this paper?

Answer 1

• Greater propensity to sell winning stocks (disposition effect) compared to losing stocks but rather sell losing funds compared to winning funds (reverse disposition effect)?
• H1: Assets that are not delegated will display a disposition effect, while those that are delegated will display a reverse-disposition effect.
• H2: If investors experience a high level of cognitive dissonance, they will display a larger disposition effect in nondelegated assets like stocks and a larger reverse-disposition effect in delegated assets like funds.
• H3: If investors focus more on the role of the fund manager instead of their own role, they will display a larger reverse-disposition effect

Question 2

What is Cognitive dissonance?

Answer 2

the discomfort that arises when a person recognizes that he or she makes choices and/or holds beliefs that are inconsistent with each other.

Two contrary cognitions that an investor can hold when faced with losses:
I am a good investor and I bought this asset for a good reason (self-image).
My asset has decreased in value (contradicting evidence).

Question 3

What are the main findings?

Answer 3

• Disposition effect: investors are 3.9% more likely to sell a stock at gain
• Reverse-disposition effect: investors are 6.6% less likely to sell a stock at gain
• Constant: probability to sell an asset that is at loss
• The authors also construct an experimental game by changing the level of cognitive dissonance that investors
  experience. They also want to ensure that differences in the behaviour of investors is not influenced by
  external factors, such as economic differences.
  o Story treatment: they show the stated reason of individuals for buying the asset on the sell screen
  o Fire treatment: increase the salience of the fund manager
  o Participants show a larger reverse-disposition effect in the game, in line with the cognitive dissonance
  theory

Question 4

What is the conclusion?

Answer 4

• The disposition effect when holding stocks, and the reverse disposition effect when holding funds are exhibited by the same investors at the same type, which backs the cognitive dissonance hypothesis, meaning that there are factors influencing the decisions other than investor characteristics
• Increasing the level of cognitive dissonance results in a larger disposition and reverse-disposition effect