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Professional trader discipline and trade disposition
Abstract
Recent evidence indicates irrational behavior among retail investors. They hold onto losses and sell winners in a manner consistent with the disposition effect. Market professionals often use the term “discipline” to indicate trading strategies that minimize potential behavioral influences. We investigate the nature of trading discipline and whether professional traders are able to avoid the costly irrational behaviors found in retail populations. The full-time traders in our sample hold onto losses significantly longer than gains, but we find no evidence of costs associated with this behavior. The successful floor futures traders in our sample exhibit trading behavior characterized as rational and disciplined. Moreover, measures of relative trading discipline have predictive power for subsequent trading success.
... We begin by examining whether our results vary across investor types. Existing research shows that sophisticated investors are less prone to behavioral biases (e.g., Feng and Seasholes 2005;Locke and Mann 2005;Grinblatt et al. 2016). Thus, we test whether sophistication reduces the effect. ...
... We begin by investigating whether our results differ across investor types. Existing research shows that sophisticated investors are less prone to behavioral biases (e.g., Feng and Seasholes 2005;Locke and Mann 2005;Grinblatt et al. 2016). Moreover, anecdotal evidence suggests that sophisticated investors bought large amounts of stocks during our sample period (e.g., Bresciani-Turroni 1937, pp. ...
... The third sophistication measure is a dummy variable that equals one for clients who are employees of our bank. Prior research shows that financial professionals tend to be more sophisticated than retail traders (e.g., Locke and Mann 2005). The fourth sophistication proxy is a dummy variable that equals one for investors who traded on margin. ...
We analyze how individual investors respond to inflation. We introduce a unique data set containing information on local inflation and security portfolios of more than 2,000 clients of a German bank between 1920 and 1924, covering the German hyperinflation. We find that individual investors buy fewer (sell more) stocks when facing higher local inflation. This effect is more pronounced for less sophisticated investors. Moreover, we document a positive relation between local inflation and forgone returns following stock sales. Our findings are consistent with individual investors suffering from money illusion. Alternative explanations, such as consumption needs, are unlikely to drive our results.
Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online
... The disposition effect (Shefrin and Statman, 1985) refers to the tendency of investors to sell winning stocks more often than losing ones. This behavioral bias has been observed across various trading environments, including options exercise (Heath, Huddart, and Lang, 1999), futures market operators (Locke and Mann, 2005;Coval and Shumway, 2005), equity investment fund shareholders (Chiu et al., 2004), and real estate sales (Genovese and Myer, 2001). ...
... Our study found participants' disposition effect significantly different from zero at a 1% level, consistent with past research on the subject in both lab experiments and archival data (Shefrin & Statman, 1985;Odean, 1998;Weber & Camerer, 1998;Genovese & Myer, 2001;Locke & Mann, 2005;Dhar & Zhu, 2006;da Costa Jr. et al., 2013). ...
This research investigates the connection between cognitive reflection and the disposition effect, a well-known bias in the behavioral finance literature. Utilizing the Cognitive Reflection Test (CRT) developed by Frederick (2005), we measured cognitive abilities in a laboratory-based experiment comprising 55 students. The main goal was to investigate the extent to which these cognitive resources might modulate the disposition effect. The study was conceptualized within the framework of the dichotomy between a deliberative long-term self and an impulsive short-term self, as detailed in Kahneman's 2011 two-systems theory. The findings indicate a significant negative correlation between cognitive abilities and the disposition effect, providing extra empirical support for Kahneman's theory. This study presents new empirical evidence of the association between cognitive reflection and behavioral biases associated with decision-making under conditions of risky, thus providing a basis for possible interventions to mitigate these biases. The implications of this study are not limited to academia, but may provide information for the development of future financial education programs to enhance the decision-making process of individuals, whether in public or private companies.
... This bias is common across experienced and novice investors across the globe (Locke and Mann, 2005) and is felt across all asset classes (Grinblatt and Keloharju, 2001), making it a popular behavioral bias for researchers. Existing research on the phenomenon has found that it reduces investors' profits due to accumulation (Odean, 1998), underreaction to announcements leading to price deviations and mispricing in the market (Frazzini, 2006). ...
... The cluster with red nodes is the largest and includes the pioneer studies in the area, including papers by Shefrin and Statman (1985), who coined the disposition effect. The (Odean, 1998), traders holding losers for longer durations (Locke and Mann, 2005) and cash-out and disposition effect (Brown and Yang, 2017). The cluster with purple nodes focuses on the disposition effect and underreaction to news (Frazzini, 2006), utility from gain or loss (Barberis and Xiong, 2009) and mental accounting and momentum (Grinblatt and Han, 2005). ...
Purpose
This paper aims to review, systematize and integrate existing research on disposition effect and investments. This study conducts bibliometric analysis, including performance analysis and science mapping and thematic analysis of studies on disposition effect.
Design/methodology/approach
This study adopted a thematic and bibliometric analysis of the papers related to the disposition effect. A total of 231 papers published from 1971 to 2021 were retrieved from the Scopus database for the study, and bibliometric analysis and thematic analysis were performed.
Findings
This study’s findings demonstrate that research on the disposition effect is interdisciplinary and influences the research in the domain of both corporate and behavioral finance. This review indicates limited research on cross-country data. This study indicates a strong presence of work on investor psychology and behavioral finance when it comes to the disposition effect. The findings of thematic analysis further highlight that most of the research has focused on prospect theory, trading strategies and a few cognitive and emotional biases.
Practical implications
The findings of this study can be used by investors to minimize their biases and losses. The study also highlights new techniques in machine learning and neurosciences, which can help investment firms better understand their clients’ behavior. Policymakers can use the study’s findings to nudge investors’ behavior, focusing on minimizing the effects of the disposition effect.
Originality/value
This study has performed the quantitative bibliometric and thematic analysis of existing studies on the disposition effect and identified areas of future research on the phenomenon of disposition effect in investments.
... The second cluster has Shapira and Venezia (2001) as the most notable paper. Shapira and Venezia (2001), Locke and Mann (2005), Odean (1999) and Coval and Shumway (2005) focus on trading behavior and offer investor attributes, beliefs and biases-based explanations for the disposition effect. The third cluster comprises Barberis and Xiong (2009), Dhar and Zhu (2006), Weber and Carmerer (1998), Kaustia (2010) and Feng and Seasholes (2005) as influential papers. ...
... The full-time traders exhibit stronger trade discipline, which leads them to future success. However, these successful traders continue to exhibit the disposition effect at reduced levels (Locke and Mann, 2005). In wealthy households, the higher financial sophistication leads to reduced levels of disposition effect except for self-employed ones (Calvet et al., 2009). ...
Purpose
The disposition effect remains one of the most significant investor behavior puzzles. This study aims to consolidate the knowledge, explore current dynamics, elicit trends and offer future research directions to demystify the disposition effect.
Design/methodology/approach
This study applies the hybrid review method. It first used bibliometric analysis (212 documents), followed by content analysis (54 articles) to analyze the breadth and depth of literature on the disposition effect.
Findings
This study presents performance analysis and science mapping. It identifies five main research streams: evidence, implications and mitigation techniques; theoretical explanations; investor biases and hedonic framing; attributes, beliefs and preferences; and implications for asset pricing and market efficiency. This study further offers future research directions for disposition effect research.
Research limitations/implications
This study deploys sequential bibliometric and content analysis. A meta-analysis of quantitative articles could provide specific insights regarding the disposition effect. Besides, this study is based on Scopus-indexed journals only.
Practical implications
This study benefits investors and portfolio managers as they learn effective ways to guard against the disposition effect. Policymakers may tweak tax laws to incentivize long-term holding, and regulators can run investor education campaigns to minimize the disposition effect’s consequences effectively.
Originality/value
To the best of the authors’ knowledge, this is probably the first hybrid review of high-quality, contemporary articles on the disposition effect that offers science mapping, research streams, future research directions and a succinct summary of theories, contexts, characteristics and methods deployed in the field of research.
... Generally, when the first half-hour return is positive and negative, there are two types of explanations for stronger and weaker predictability. First, if the stock behavior effect, investors need to hold the stock and sell the last half hour on bad news; second, with asymmetric cost (Coval & Shumway, 2005;Locke & Mann, 2005;Odean, 1998). Ito and Hashimoto (2006) shows that conditional on negative past returns is stronger than positive past return in the intraday crosssectional momentum. ...
... Ito and Hashimoto (2006) shows that conditional on negative past returns is stronger than positive past return in the intraday crosssectional momentum. Due to the disposition effect, investors and stockholders are reluctant to sell due to the bad news (Haigh & List, 2005;Locke & Mann, 2005). The stockholders are widely distributed by ownership rights in the stock market (Sadaf et al., 2019). ...
This paper analyzes the statistical impact of COVID-19 on the S&P500 and the CSI300 intraday momentum. This study employs an empirical method, that is, the intraday momentum method used in this research. Also, the predictability of timing conditional strategies is also used here to predict the intraday momentum of stock returns. In addition, this study aims to estimate and forecast the coefficients in the stock market pandemic crisis through a robust standard error approach. The empirical findings indicate that the intraday market behavior an unusual balanced; the volatility and trading volume imbalance and the return trends are losing overwhelmingly. The consequence is that the first half-hour return will forecast the last half-hour return of the S&P500, but during the pandemic shock, the last half-hour of both stock markets will not have a significant impact on intraday momentum. Additionally, market timing strategy analysis is a significant factor in the stock market because it shows the perfect trading time, decides investment opportunities and which stocks will perform well on this day. Besides, we also found that when the volatility and volume of the S&P500 are both at a high level, the first half-hour has been a positive impact, while at the low level, the CSI300 has a negative impact on the last half-hour. In addition, this shows that the optimistic effect and positive outlook of the stockholders for the S&P500 is in the first half-hours after weekend on Monday morning because market open during the weekend holiday, and the mentality of every stockholder’s indicate the positive impression of the stock market.
... This behavioral bias has been investigated from several points of view. (Odean 1998), (Locke and Mann 2005), (Douglas and Diltz 2004), (Nolte 2012), and (Bouteska and Regaieg 2018) studied it in the context of real trading data. A different approach was chosen by (Weber and Camerer 1998), who proposed the very first experimental study of the disposition effect, which is described in the subsequent section. ...
... (Douglas and Diltz 2004) confirmed the existence of the disposition effect among day trading transactions. (Locke and Mann 2005) focused on the specifics of the trading discipline and concluded that even professional traders succumb to the disposition effect but did not find any evidence for costs arising from this fact. (Barberis and Xiong 2009) examined whether the disposition effect is predictable based on the preferences described in Prospect Theory, considering two implementations: firstly, preferences specified over annual gains and losses; secondly, preferences specified over realized gains and losses. ...
We examine the effect of selected limit order tools (stop loss, take profit, and trailing stop) on the disposition effect, a well-known behavioral bias, by using experimental trading data. Our presumption is that the limit orders should significantly eliminate this behavioral bias, which may lead to higher losses than feasible for a trader. The traders of our data sample can be considered as a sample of beginners or less informed traders. Based on our analysis it is possible to conclude that limit orders have a significant impact on the disposition effect. Traders using these tools were able not only to avoid this behavioral bias, but even reverse it, which is, as far as we know, a unique result within the existing literature. Moreover, we found out that the impact of eliminating of the disposition effect by limit orders use is positive, as it may lead to significant loss reduction. On the other hand, the effect on profits is insignificant.
... In the investment process, most investors are boundedly rational in reality. Most of them have irrational behaviors such as the tendency to sell profitable stocks prematurely and hold loss-making stocks for a long time (e.g., Brown et al., 2006;Locke & Mann, 2005;Shefrin & Statman, 1985), overconfidence (e.g., Glaser et al., 2013;Ho et al., 2016), regret aversion (e.g., Zeelenberg & Beattie, 1997) and so on. Ideas about the role of regret were long present in decision research (e.g., Savage, 1951), and anticipatory aspects of regret were explicitly incorporated in Bell's (1982) and Loomes and Sugden's (1982) "regret theory". ...
Most scholars only consider regret value in financial decision-making, but pay little attention to the influence of ecstatic attitudes. However, in practice, both positive and negative feelings of investors affect their economic decisions. Based on this, two definitions of rejoice value are advanced. In one case, the rejoice value is defined as the distance between the minimum and the obtained return. In the other case, when the real return is greater than the return of equal weight portfolio, the rejoice value is measured by the distance between them. Corresponding to the above two definitions, we set the regret values respectively. Then, the regret aversion coefficient and rejoice coefficient are introduced, based on which, two regret–rejoice functions are defined by the linear weighting method. Moreover, two novel regret–rejoice expectation minimization fuzzy portfolio models are constructed by the above two new definitions. The security return is regarded as a fuzzy variable. Based on credibility theory, the corresponding regret–rejoice expectation is calculated by the fuzzy variable’s realization value and membership value. Finally, numerical examples based on China Shanghai Stock Exchange 180 Index are given to verify the effectiveness and practicality of our proposed models. Compared with the original model which considers only regret value, our novel regret–rejoice models have more efficient results in Sharpe ratio, monthly and weekly average logarithmic returns and cumulative logarithmic returns.
... Furthermore, Locke and Mann (2005) have established a positive relationship between an investor's skills, such as trading discipline, and the future success of their investments. Similarly, Grinblatt and Keloharju (2001) highlighted that professional investor trades differently from retail or individual investor. ...
The performance of foreign investors relative to domestic investors has been a subject of mixed evidence. While foreign investors are often perceived to underperform due to an information disadvantage, they are also known for their aggressive trading and superior performance in initiated orders. We provide further clarity on this issue. Specifically, by analyzing over five million transactions on the Jakarta Stock Exchange, our findings reveal that foreign investors consistently outperform domestic investors in terms of both annualized returns and profit amounts. Further investigation attributes this outperformance to the higher sophistication of foreign investors, who demonstrate superior stock-picking abilities and effective growth investing strategies.
... Dimson et al. (2017) calculated the effect of a momentum strategy based on the performance of the top 100 UK stocks and found a clear advantage over a period of months 4 . Though one study by Locke and Mann (2005) showed a neutral outcome from the disposition effect, a review by O'Brien et al. (2010) shows that momentum strategies over a period of 12 months generally yield a premium, with the main benefit arising from counteracting the disposition effect by selling losing stocks. For longer periods, the outcome changes. ...
Investment in stocks is increasingly dependent on artificial intelligence (AI), but the psychological and social factors that affect stock prices may not be fully covered by the measures currently used in AI training. Here, we search for additional measures that may improve AI predictions. We start by reviewing stock price movements that appear to be affected by social and psychological factors, drawing on stock market behaviour during the COVID-19 pandemic. A review of processes that are likely to produce such stock market movements follows: the disposition effect, momentum, and the response to information. These processes are then explained by regression to the mean, negativity bias, the availability mechanism, and information diffusion. Taking account of these processes and drawing on the consumer behaviour literature, we identify three factors which may not be covered by current AI training data that could affect stock prices: publicity in relation to capitalization, stock-holding penetration in relation to capitalization, and changes in the penetration of stock holding.
... It has also been confirmed in other countries and regions, such as the European Union (Vinokur, 2009), the United Kingdom (Richards & Rutterford et al., 2017), Macao (Chui, 2001), etc. According to the research of Genesove & Mayer (2001), Heath et al. (1999) and Locke & Mann (2005), the disposition effect also exists in the real estate market, options market and futures market and has an essential impact on these markets. ...
Using the transaction data of the stock market and financial data of listed companies from 2003 to 2021 in China, we explore the existence form of the disposition effect. Then, we combine the Bayesian learning process with the DSSW model to investigate the disposition effect's size and performance when market conditions differ from investors' irrational beliefs. We find the disposition effect in China is asymmetric V-shaped and negatively correlates with investor sentiment significantly. In addition, affected by sentiment, its performance is opposite in the bull market and bear market. The above research and conclusions have theoretical and practical significance for understanding the disposition effect, optimizing investors' decision-making, and strengthening the capital market infrastructure.
Utilizando los datos de transacciones del mercado de valores y los datos financieros de las empresas cotizadas de 2003 a 2021 en China, exploramos la forma de existencia del efecto de disposición. A continuación, combinamos el proceso de aprendizaje bayesiano con el modelo DSSW para investigar el tamaño y el rendimiento del efecto de disposición cuando las condiciones del mercado difieren de las creencias irracionales de los inversores. En China, el efecto de disposición tiene forma de V asimétrica y una correlación negativa significativa con el sentimiento de los inversores. Además, afectado por el sentimiento, su rendimiento es opuesto en el mercado alcista y en el mercado bajista. La investigación y las conclusiones anteriores tienen importancia teórica y práctica para comprender el efecto de disposición, optimizar la toma de decisiones de los inversores y reforzar la infraestructura del mercado de capitales.
... Target and tolerance in holding and selling decisions Professionals tend to exhibit less disposition effect (Guenther and Lordan, 2023;Locke and Mann, 2005;Shapira and Venezia, 2001). From the original research, self-control was introduced as one of the driving factors that must be considered when exercising assets (Shefrin and Statman, 1985). ...
Purpose
This paper aims to explore the development of investment decision tools by understanding the rationality behind the disposition effect. We suspect that not all disposition decisions are irrational. The decisions should be evaluated based on the bounded rationality of the individuals’ target and tolerance level, which is not covered in previous literature. Adding the context of individual preference (target and tolerance) in their decision could improve the classic measurement of disposition effect.
Design/methodology/approach
The laboratory web experiment is prepared to collect the responses in holding and selling the stocks within 14 days. Two groups of Gen Z investors are observed. The control group makes a decision based on their judgment without any system recommendation. In contrast, the second group gets help inputting their target and tolerance. Furthermore, the framing effect is also applied as a reminder of their target and tolerance to induce more holding decisions on gain but selling on loss.
Findings
The framing effect is adequate to mitigate the disposition effect but only at the early day of observation. Bounded rationality explains the rationality of liquidating the gain because the participants have reached their goal. The framing effect is not moderated by days to affect the disposition effect; over time, the disposition effect tends to be higher. A new measurement of the disposition effect in the context of bounded rationality is better than the original disposition effect coefficient.
Practical implications
Gen Z investors need a system aid to help their investment decisions set their target and tolerance to mitigate the disposition effect. Investment firms can make a premium feature based on real-time market data for investors to manage their assets rationally in the long run. Bounded rationality theory offers more flexibility in understanding the gap between profit maximization and irrational decisions in behavioral finance. The government can use this finding to develop a suitable policy and ecosystem to help beginner investors understand investment risk and manage their assets based on subjective risk tolerance.
Originality/value
The classic Proportion Gain Realized (PGR) and Proportion Loss Realized (PLR) measurements cannot accommodate several contexts of users’ targets and tolerance in their choices, which we argue need to be re-evaluated with bounded rationality. Therefore, this article proposed new measurements that account for the users’ target and tolerance level to evaluate the rationality of their decision.
... It has also been confirmed in other countries and regions, such as the European Union (Vinokur, 2009), the United Kingdom (Richards and Rutterford et al., 2017), Macao (Chui, 2001), and so on. According to Genesove and Mayer (2001), Heath and Huddart et al. (1999) and Locke and Mann (2005), the disposition effect also exists in the real estate market, option market and futures market, and has an important impact on these markets. Lehenkari and Perttunen (2004)found that in a bear market, due to the increase in the number of loss stocks in the portfolio, the probability of selling loss stocks may be higher than that of profitable stocks, so the disposition effect becomes weaker. ...
... Disposition bias (Shefrin & Statman, 1985), one of the most documented investor biases in the behavioral finance literature, is considered a typical decision bias among investors in financial markets (Li et al., 2021) and affects both institutional and individual investors (Locke & Mann, 2005;Odean, 1998b;Shu et al., 2005;Van Dooren & Galema, 2018). It indicates the tendency to sell winning assets quickly and hold on to losing assets for a long time. ...
The paper proposes a behavioral model of investment decisions under the Adaptive Market Hypothesis (AMH) in the Moroccan financial market. This model examines the existence of rationality alongside irrational behavioral biases that might affect investors, as well as investors' tendency to adapt to market conditions. The paper uses Partial Least Squares Structural Equation Modeling (PLS-SEM) to test the proposed hypothetical model based on primary data collected from individual and institutional investors active in the Moroccan financial market. The results of the study show that, although investors tend to follow the rational decision-making process, some irrational biases might arise during this process. Specifically, the empirical evidence reveals that during the 'searching information" stage, investors are subjected to the disposition effect. Then, the losses accumulated because of the disposition bias attenuate the overconfidence bias, and prompt investors to correct their perception of risk rationally. Therefore, the findings are consistent with the adaptive investor behavior implied by the AMH theory. Regarding investor type, the study shows that individual and institutional investors are likely to be affected by behavioural biases alike. This study is the first to use a different approach, to empirically test the AMH, based on heterogeneous and adaptive investor behavior using primary data. This approach can provide a more accurate measure of investor behavior dynamics. The study is also the first to use the PLS approach to investigate adaptive investor behavior, both at the level of individual and institutional investors, in the Moroccan context. This study has implications for trading strategies and regulatory policies. Insights from the research make investors aware of their biases, which could help them try to de-bias themselves by complying with certain rational rules. In addition, the study findings suggest that investors can exploit arbitrage opportunities resulting from irrational behavior. Moreover, the results of the study enable policymakers to understand the real behavior of investors and take appropriate regulatory measures to prevent the market from being inefficient and unstable.
... Another study (Choe and Eom 2009) observed a negative relationship between the disposition effect and investment performance, indicating that investors prone to the disposition effect were more likely to experience inferior investment performance in the future. However, Locke and Mann (2005) found no measurable costs associated with professional traders who are averse to realizing losses. Thus, the study suggests that traders who exhibit the disposition effect may not necessarily suffer significant costs. ...
This study investigates the anchoring bias and disposition effect in investor trading decisions under different market volatility conditions (stable and volatile markets) and examines their impact on portfolio performance. Employing a quasi-experimental design, participants engage in interactive trading with four securities—two with potential negative returns and two with positive returns—within a simulated asset market. The findings reveal the presence of both the disposition effect and the anchoring bias among individual investors in India. Notably, market volatility influences these behavioral biases, with the disposition effect more pronounced in volatile markets, while the anchoring bias is significant in stable markets. Furthermore, investors exhibiting the disposition effect tend to have lower portfolio performance, while those influenced by the anchoring bias achieve relatively better results. These insights can aid individual investors in recognizing their behavioral biases and making informed trading decisions to enhance portfolio performance. Additionally, this study presents valuable suggestions to financial institutions and regulatory government agencies engaged in similar experiments, with the goal of improving financial decision-making and investment behavior.
... Jordan and Diltz (2004) showed that approximately 65% of investors in their sample held losing investments longer than profitable ones. While Locke and Mann (2005) found there was a significant difference in the length of time that gains and losses are held. Professional traders hold onto losing positions for much longer than winning positions in respect of all the contracts examined. ...
In this paper it is attempted to explore current trends in Financial Accounting, that connect research endeavors in the relatively new branch of Behavioral Finance, with the impact of subjectivity on the accounting cycle of each fiscal year, as well as on the preparation of financial statements. The investigation of subjective factors in Financial Accounting expands its scope, while the systematic utilization of its two-way relationship with the field of Neurofinance (unbiased data) may create a broader framework of knowledge for the further improvement of the investment process, through an understanding of the methodology required by accounting operations and rules up until the preparation of financial statements. By extension, a better understanding of how financial markets operate will be beneficial not only for governments wishing to promote savings incentives and responsible management, but also for supervisory authorities seeking to ensure that the market for personal financial services operates rationally and without bias. Keywords: Behavioral Finance, Neurofinance, Financial Accounting JEL Classification: D87, G41, M41
... Dhar and Zhu (2002), Lin et al. (2006), Choe and Eom (2009), Goo et al. (2010), and Suyu and Huang (2010) show that retail investors exhibit stronger disposition effects than institutional investors. On the other hand, Frino et al. (2004), Haign and List (2005), Coval and Shumway (2005), Locke and Mann (2005), and Frazzini (2006) find that professional traders, such as futures traders, proprietary traders, or fund managers are also subjected to the disposition biases. Despite the extensive literature on the severity of the disposition effect among different types of investors, very few studies examine the phenomenon of the disposition effect from the perspective of shorting behavior of short sellers. ...
This paper investigates how the disposition biases affect the trading behavior of partially informed short sellers. We gauge the short sellers’ closing of short positions by the ratio of weekly closed short positions to the total number of shorted shares and measure the short-sale capital gains overhang. Using the short sale data in Taiwan, we show that the short sellers’ closing of short positions can be subjected to the disposition biases while they are partially informed in the sense that a higher level of the short balance still predicts a lower stock return. As a result, the short sellers close their short positions too early to fully exploit the subsequent stock returns. Furthermore, we find that the disposition effects are more pronounced for the stocks with smaller market capitalizations, lower liquidity, lower institutional ownership, and higher return volatilities, while it is weaker for the stocks with higher borrowing costs.
10.1016/j.pacfin.2024.102479
... They present that foreign investors likely use momentum strategies, while domestic investors tend to be contrarian traders. Locke and Mann (2005) state that individual investors have some disposition effects because of their irrational behavior. Their evidence shows that individuals tend to hold losers and sell winners because individuals do not want to realize losses. ...
... The disposition effect, first raised by Shefrin and Statman [1], refers to the phenomenon that investors are less inclined to sell properties with losses relative to the reference price than properties with gains. This disposition effect is a well-known psychological phenomenon and well documented by a series of papers, including Shefrin and Statman [1], Odean [2], Weber and Camerer [3], Genesove and Mayer [4], Locke and Mann [5], Kumar [6], Hong et al. [7], and so on. However, empirical studies on the disposition effect mainly focuses on the stock markets, while few studies have been conducted on the real estate market. ...
This paper examines the relationship between property return and seller behavior and aims to test the disposition effect in China’s real estate market. Using transaction data in Beijing, we find that loss properties have a lower sell propensity relative to gain properties, confirming the existence of the disposition effect. We also find that the disposition effect is more pronounced in samples with shorter holding periods. Sellers with financial constraints and popular projects are more likely to show the disposition effect. Furthermore, we find that sellers exhibit loss aversion; specifically, sellers with loss properties are likely to set a higher listing price, which provides indirect evidence for the disposition effect.
... First, we consider the role of investor sophistication in cancellation and revision strategies. Recent studies on behavioral finance have found that investor sophistication differs in the possession of information, pricing kernel, and cost of monitoring information that leads to major differences in trading behavior and performance (Locke and Mann, 2005;Aitken et al., 2007;Polkovnichenko and Zhao, 2013). This study extends the recent literature and shows that sophistication can influence differences in cancellations and revisions among different investor categories due to submission risk and information shocks. ...
We investigate whether investors’ levels of sophistication can result in differences in their cancellation and revision strategies. We use a unique dataset that encompasses all limit orders in the Taiwan futures market. Our results find that when investors face a higher free-option risk (non-execution risk), institutional investors increase their cancellations and revisions to reduce their risk of being picked off (non-execution). By contrast, individual investors are less likely to cancel and revise their limit orders. Higher informational volatility (transitory volatility) can improve (reduce) the revisions and cancellations of limit orders for all investor categories.
... Contrarily, O'Connell and Teo (2009) confirm that institutional investors are not subject to the disposition effect in their currency trades. Locke and Mann (2005) also find evidence of the disposition effect in professional futures traders. ...
This paper develops a comprehensive bibliometric analysis of a well-known bias in behavioral finance: the disposition effect. Since the term was coined in 1985, the tendency for investors to sell winners too soon and hold losers in the portfolio has been amply studied. Based on data from Web of Science and the tool VOSviewer, we obtain a complete picture of the evolution of the research on the disposition effect from citation and co-citation perspectives. The research topic has intensely increased the number of publications during the last years, and we also analyze the evolution of the lines of research. The analysis includes the yearly impact factors of the journals analyzed to ensure that the quality of publications remains. A temporal overlay visualization map shows the most used terms through time to explore future venues; disposition effect seems to be less studied alone, whereas researchers try to find interrelations with other behavioral biases.
... Their information processing capacity is less subject to market noise and can identify the real motivation of engagement enterprises. Simultaneously, institutional investors tend to be more rational in the market, while retail investors are susceptible to 'impulsive' investments due to the lack of accurate information or irrational regard of noise as information (Locke & Mann, 2005). Third, unlike equity financing, creditors do not enjoy the residual claim of the firm. ...
This paper incorporates corporate targeted poverty alleviation behaviour into the bond pricing framework for the first time, using a sample of A-share listed companies that issued corporate bonds from 2016 to 2018 to study the impact and mechanism of targeted poverty alleviation behaviour on bond credit spreads. We find that bond-issuing companies’ targeted poverty alleviation behaviour can significantly reduce bond credit spreads, which are more pronounced in subsamples with higher credit risk and lower credit rating and of active participants. In addition, companies’ targeted poverty alleviation behaviour has improved corporate reputation and strategic resource acquisition and reduced information asymmetry and agency costs. Consequently, these results indicate that corporate targeted poverty alleviation is essentially embodied as value features, not tool features, and bond investors can identify the true motivations of engaged enterprises.
... Other significant keywords are "prospect theory", "investment decisions", "loss aversion", "portfolio choice" and "anchoring". One of the most cited studies discussing overconfidence is (Daniel et al., 2002) with 252 citations and (Glaser & Weber, 2007) with 225 citations while the most cited literature in disposition effect is of (Barberis & Xiong, 2012) with 120 citations and (Locke & Mann, 2005) with 146 citations. ...
This paper presents a bibliometric analysis of relevant publications in the field of behavioral finance and behavioral accounting. The analysis shows that the emerging themes of research in recent years in behavioral finance is on investors’ sentiment, social media, investors’ attention, and financial literacy. In the field of behavioral accounting, biases such as overconfidence, framing effects or cognitive constraints on information processing, have been explored in greater detail. Other than cognitive biases, this field includes studies such as behavioral tax, organizational ecology, and performance evaluative style of organization, among others. Interestingly, our analysis suggests that research in behavioral accounting is comparatively underdeveloped than research in behavioral finance. This bibliometric analysis has been extended by network analysis using, “Visualization of similarities, (VOS) viewer” software. Using the themes generated here the direction for future scope of research work has been discussed.
This study investigates how institutional investors' attention on the earnings announcement day affects corporate investment decisions. I find that the investment of firms receiving abnormal institutional attention is approximately 1.8 times more sensitive to their stock price than that of others. This effect is more pronounced when institutional investors have greater incentives to produce information and when corporate managers have greater incentives and capability to employ the incremental information contained in the stock price. These findings suggest that attention encourages institutional investors to incorporate private information into stock prices, which provides a useful guide for managers' investment decisions.
The house money effect is the tendency of individuals to exhibit risk-seeking behavior after a prior gain. Individuals differentiate their perceived gains with own money. This behavioral bias influences human behavior in future decision-making. This review examines the implications of the house money effect on an individual investor’s financial decision-making. Our study adopts a systematic review approach to understand and extensively synthesize the existing literature. The study considered 34 articles from the Scopus database. The study provides an overview of the literature regarding theories, methodology, research opportunities, and developments in the house money effect. The study points out the situational factors influencing the house money effect and the association of the bias with other behavioral biases. This review identifies the gaps in the literature and provides directions for future research to deepen the understanding of the effect of house money on individual investors. This study builds a strong framework for future research.
I show that hedge funds react to unrealized losses on their passive positions by engaging with the management. The hedge fund managers’ psychological response is consistent with cognitive dissonance: They blame the firms’ management and switch to activism. The loss, which is hedge fund-investment specific, is distinct from economic factors such as the firm’s industry-adjusted performance. Loss-driven activism is more likely to be unfocused on specific issues and results in worse firm performance. This study shows that an overlooked consequence of unrealized losses is to trigger an active engagement with the firm.
We first provide evidence of investor inattention to a very simple and well-known capital gains tax exemption in the Brazilian stock market. We then show that inattentive investors exhibit worse trading performance and stronger trading biases even after controlling for several investor-level variables, such as past trading experience. The evidence is consistent with inattention being one of the explanations for the prevalence of behavioral biases.
This paper was accepted by David Sraer, finance.
Funding: F. Chague and B. Giovannetti gratefully acknowledge financial support from Conselho Nacional de Desenvolvimento Científico e Tecnológico.
Supplemental Material: The internet appendix and data are available at https://doi.org/10.1287/mnsc.2021.02516 .
We find that managers are less likely to repurchase stocks when they lose money on past stock repurchases but find no robust evidence that past gains on repurchases influence future repurchasing activity. This asymmetric sensitivity is strongest for young CEOs and those with the shortest tenure. Also, future repurchases are more sensitive to past repurchase losses for CEOs whose previous lifetime experience with the stock market is unfavorable. The sensitivity of future repurchases to past losses costs firms, on average, about 3.7% per year. When this cost is decomposed into systematic and idiosyncratic components, we find that nearly half (1.8%) comes from mistiming idiosyncratic shocks. Past losses on repurchases have a significant and negative impact on the CEO’s future bonus and increase the likelihood that future CEO termination is involuntary. We also find that negative outcomes from past repurchases encourage the subsequent use of dividends. Our findings suggest that outcomes of past repurchases have economically significant consequences through both nonbehavioral (career concerns) and behavioral (snakebite effect) factors.
This paper was accepted by Tyler Shumway, finance.
We conduct the first survey experiment to understand public attitudes about the realization rule for capital gains. This rule requires that assets usually must be sold before gains on them are taxed and thus makes taxing capital income much harder. We have three main findings. First, respondents strongly prefer to wait to tax gains on stocks until sale: 75% to 25%. But the flip side is that there is surprisingly strong support for taxing gains on assets at sale or transfer, including at death, in areas where current law never taxes those gains. Second, these stated views change only modestly when randomized participants observe a policy debate composed of videos explaining both the pros and cons of taxing before sale, though the pro and con treatments have large effects individually. And, third, among many possible explanations of these attitudes, we find particular evidence for three: mental accounting; status quo effects; and a desire to tax consumption, not income.
This paper explores the long-lasting impact of investors' first impression of participation in the stock market and the disposition effect. Using a unique dataset of account-level transaction records from a large brokerage firm in China, we find strong evidence for the existence of a disposition effect of Chinese retail investors. Our empirical results suggest that investors exhibit a stronger disposition effect if they initially participate in the stock market in periods of lower market returns, lower investor sentiment, higher market volatility, or higher economic policy uncertainty (EPU). The evidence enhances our understanding of the role of investors' early experience in stock market decisions and the determinants of behavioural biases in investment decisions.
Using monthly fund-level portfolio holdings data on Indian equity mutual funds, we explore the predictable patterns in the trading biases of fund managers induced by changing attention allocation patterns. In an emerging market setting, we investigate the tendency of fund managers to sell winners and increase their exposure to losing stocks. Their biases are examined during two states of economic cycles. We adjust for random choice probability while selecting funds for reasons unrelated to the disposition effect. Our research contributes to the relatively nascent psychology-based asset pricing literature by examining fund managers’ psychology concerning financial decision-making.
Extant theories on the disposition effect are largely silent on most of the disposition-effect related trading patterns, including the V-shaped probabilities of buying and selling against unrealized profit. On the other hand, portfolio rebalancing and learning have been shown to be important, even for retail investors. We show that rational rebalancing with transaction costs and unknown expected returns can generate many disposition-effect-related trading patterns, including the V-shape results. Our paper complements the extant theories by suggesting that portfolio rebalancing may also constitute a significant driving force behind the disposition effect and the related patterns.
This study examines intraday time series momentum in Bitcoin. Unlike stock markets, Bitcoin trades 24 h a day and therefore has not got a clear opening and closing period. Therefore, we use trading volume as a proxy for the market trading time and show that the first half-hour positively predicts the last half-hour return. We find that the first trading sessions with the highest volume or volatility are associated with the greatest predictability for intraday time series momentum. We also show that intraday momentum-based trading yields substantial economic gains in terms of market timing and asset allocation, especially in periods of a market downturn in Bitcoin. Consistent with the finding in foreign exchange markets, our results also show that the Bitcoin intraday momentum is driven by liquidity provision rather than late-informed trading.
Although a cornerstone of traditional finance theory, empirical evidence in support of a positive mean-variance relation is far from conclusive, with the behavior of retail investors commonly thought to be one of the root causes of departures from this expected relationship. The behavior of institutional investors, conventionally thought to be sophisticated and rational, has recently come under closer scrutiny, including in relation to investor sentiment. Drawing together these two strands of literature, this paper examines the impact of institutional investor sentiment on the mean-variance relation in six regions, including Asia (excl. Japan), Eastern Europe, Eurozone, Japan, Latin America, and the US, and across thirty-eight markets. Empirical evidence supports the differential impact of institutional investor sentiment on the mean-variance relation (i.e., positive or negative), both across regions and across markets. In particular, for markets with cultural proneness to overreaction and a low level of market integrity institutional investor sentiment tends to distort the risk-return tradeoff.
The distress anomaly reflects the abnormally low returns of high credit risk stocks during financial distress. Evidence from stocks and corporate bonds reinforces the anomaly and challenges rationales based on shareholders’ ability to extract value from bondholders, time-varying betas, lottery-type preferences, biased earnings expectations, and limits-to-arbitrage. Moreover, mispricing of distressed stocks and bonds is associated with excess investment and excess external financing. Potential real distortions are materially understated when assessed based only on equity mispricing. We emphasize the important role of corporate bonds in dissecting the distress anomaly, and show that the anomaly is an unresolved puzzle.
Concerns regarding the assumptions of the Efficient Market Hypothesis have led to a greater emphasis on how the behaviour of different groups of traders might impact the evolution of financial markets; ideas encapsulated in the Adaptive Markets Hypothesis (AMH). A key assumption of the AMH is that the dynamics of competition and natural selection will drive ‘noise traders’, those least likely to push prices to efficient levels because they follow sub-optimal trading strategies, to exit the market. To test the key assumptions of the AMH, survival analysis is employed to examine the behaviour of retail spread-traders, a group who are widely reported to include many noise traders. Analysis of the trades executed by 5,164 individuals in the period 24th March 2006 to 7th February 2012 found that the least profitable and those who adopted ill-disciplined trading strategies tended to cease trading sooner than others. These findings are consistent with the AMH. However, profitable traders were also found to be more likely to cease trading than the average trader and a V-shaped relationship was found between a trader's Sharpe ratio and their likelihood of ceasing to trade (cf. the average trader). Furthermore, during the financial crisis of 2008-09, the disposition effect of traders and the proportion of noise traders increased and throughout the period of the study, the ill-discipline of new generations of traders increased. The results suggest that the forces underpinning the AMH are complex and the move towards market efficiency may not be as straightforward as some expect.
Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreac-tion, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique. 1998 Elsevier Science S.A. All rights reserved.
In this Paper we measure psychological traits and show that they significantly affect behaviour and performance in a financial context. Based on the answers of 184 subjects to a psychological questionnaire we measured their degree of overconfidence, ie. the extent to which they overestimate the precision of their information, and self-monitoring, which is a form of social intelligence. The subjects also participated in an experimental financial market under asymmetric information in the spirit of Plott and Sunder (1988). In line with the hypothesis that they suffer from the winner's curse, overconfident subjects are found to earn relatively low trading profits. In contrast, our finding that high self-monitors earn relatively large trading profits is consistent with the hypothesis that they are relatively good at anticipating the trading motivations of the other traders.
How is risk-taking affected by prior gains and losses? While normative theory implores decision makers to only consider incremental outcomes, real decision makers are influenced by prior outcomes. We first consider how prior outcomes are combined with the potential payoffs offered by current choices. We propose an editing rule to describe how decision makers frame such problems. We also present data from real money experiments supporting a "house money effect" (increased risk seeking in the presence of a prior gain) and "break-even effects" (in the presence of prior losses, outcomes which offer a chance to break even are especially attractive).
This paper analyzes experimentally if psychological traits and cognitive biases affect trading behaviour and performance. Based on the answers of 67 subjects to a psychological questionnaire we measured their degree of overconfidence, impulsiveness and self-monitoring, and their availability, representativeness and confirmation biases. The 67 subjects also participated in an experimental financial market, in the spirit of Plott and Sunder (1988). We find that impulsive subjects tend to place more orders but do not incur larger losses. We also find that overconfident subjects and subjects prone to the confirmation and representativeness biases have a greater tendency to place unprofitable orders. This negative impact of cognitive biases on trading performance is sronger when subjects have acquired some experience of the game. This suggests that biased subjects engage in improper learning.
Contrary to theoretical expectations, measures of willingness-to-accept greatly exceed measures of willingness-to-pay. This paper reports several experiments that demonstrate that this "endowment effect" persists even in market settings with opportunities to learn. Consumption objects (e.g., coffee mugs) are randomly given to half the subjects in an experiment. Markets for the mugs are then conducted. The Coase theorem predicts that about half the mugs will trade, but observed volume is always significantly less. When markets for "induced-value" tokens are conducted, the predicted volume is observed, suggesting that transactions costs cannot explain the undertrading for consumption goods. Copyright 1990 by University of Chicago Press.
The equity premium puzzle refers to the empirical fact that stocks have outperformed bonds over the last century by a surprisingly
large margin. We offer a new explanation based on two behavioral concepts. First, investors are assumed to be “loss averse,”
meaning that they are distinctly more sensitive to losses than to gains. Second, even long-term investors are assumed to evaluate
their portfolios frequently. We dub this combination “myopic loss aversion.” Using simulations, we find that the size of the
equity premium is consistent with the previously estimated parameters of prospect theory if investors evaluate their portfolios
annually.
It is a common view that private information in the foreign exchange market does not exist. We provide evidence against this view. The evidence comes from the introduction of trading in Tokyo over the lunch-hour. Lunch return variance doubles with the introduction of trading, which cannot be due to public information since the flow of public information did not change with the trading rules. Having eliminated public information as the cause, we exploit recent results in microstructure to discriminate between the two alternatives: private information and pricing errors. Three key results support the predictions of private-information models. First, the volatility U-shape flattens: greater revelation over lunch leaves a smaller share for the morning and afternoon. Second, the U-shape tilts upward, and implication of information whose private value is transitory. Finally, the morning exhibits a clear U-shape when Tokyo closes over lunch, and it disappears when trading is introduced.
In this paper, we analyze the investment patterns of a large number of clients of a major Israeli brokerage house during 1994. We compare the behavior of clients making independent investment decisions to that of investors whose accounts were managed by brokerage professionals. Our main objective is to investigate whether the disposition effect (i.e., the tendency to sell winners quicker than losers), demonstrated in the US only for individual investors, also holds for professional investors. This analysis is important, as accepted financial theory predicts that prices are determined mainly by decisions made by professionals. We show that both professional and independent investors exhibit the disposition effect, although the effect is stronger for independent investors. The second objective of our study is the comparison of trade frequency, volume and profitability between independent and professionally managed accounts. We believe that these comparisons not only provide insights of their own, but also help to put the differences in the disposition effect in a wider perspective. We demonstrate that professionally managed accounts were more diversified and that round trips were both less correlated with the market and slightly more profitable than those of independent accounts.
Using data from Finland, this study analyzes the extent to which past returns determine the propensity to buy and sell. It also analyzes whether these differences in past-return-based behavior and differences in investor sophistication drive the performance of various investor types. We find that foreign investors tend to be momentum investors, buying past winning stocks and selling past losers. Domestic investors, particularly households, tend to be contrarians. The distinctions in behavior are consistent across a variety of past-return intervals. The portfolios of foreign investors seem to outperform the portfolios of households, even after controlling for behavior differences.
Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique.
In this paper, we analyze the investment patterns of a large number of clients of a major Israeli brokerage house during 1994. We compare the behavior of clients making independent investment decisions to that of investors whose accounts were managed by brokerage professionals. Our main objective is to investigate whether the disposition effect (i.e., the tendency to sell winners quicker than losers), demonstrated in the US only for individual investors, also holds for professional investors. This analysis is important, as accepted financial theory predicts that prices are determined mainly by decisions made by professionals. We show that both professional and independent investors exhibit the disposition effect, although the effect is stronger for independent investors.The second objective of our study is the comparison of trade frequency, volume and profitability between independent and professionally managed accounts. We believe that these comparisons not only provide insights of their own, but also help to put the differences in the disposition effect in a wider perspective. We demonstrate that professionally managed accounts were more diversified and that round trips were both less correlated with the market and slightly more profitable than those of independent accounts.
Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique.
Recent empirical research in finance has uncovered two families of pervasive regularities: underreaction of stock prices to news such as earnings announcements, and overreaction of stock prices to a series of good or bad news. In this paper, we present a parsimonious model of investor sentiment, or of how investors form beliefs, which is consistent with the empirical findings. The model is based on psychological evidence and produces both underreaction and overreaction for a wide range of parameter values.
The results of an asset market experiment, in which 64 subjects trade two assets on eight markets in a computerized continuous double auction, indicate that objectively irrelevant information influences trading behavior. Moreover, positively and nega- tively framed information leads to a particular trading pattern, but leaves trading prices and trading volume una ected. In addition, we provide support for the dis- position e ect. Participants who experience a gain sell their assets more rapidly than participants who experience a loss, and positively framed subjects generally sell their assets later than negatively framed subjects.
Most discussions of the cost of investing in equity mutual funds focus on one component of cost, the expense ratio, and ignore another significant cost, sales loads. As a result, conclusions about the total cost of mutual fund investing have often been incomplete or misleading. This paper analyzes trends in the cost of investing in equity mutual funds from 1980 to 1997 using a measure called "total shareholder cost." This measure includes all major costs of investing in a mutual fund and is comparable to the fee and expense information required by the U.S. Securities and Exchange Commission in the mutual fund prospectus. The paper finds that the average cost of invest- ing in equity mutual funds has dropped by more than one-third since 1980. The paper also finds evidence of economies of scale among equity funds.
Economists and investment professionals have long been puzzled by the tendency of individual investors to sell the winners from their stock portfolio and to hold on to the losers. I analyze the daily trading records of 78,000 clients of a discount brokerage house over six years and document, surprisingly, that such behavior (known as the disposition effect) is concentrated primarily in large-cap stocks. Trades in stocks at the bottom 40 percent of the market capitalization distribution exhibit a reverse disposition effect: investors keep their winners and realize their losers. Moreover, the relationship between firm size and the disposition effect appears to be monotonic. The larger the market capitalization of the firm, the more likely people are to realize their gain and to hold on to their loss. This new evidence challenges the current view of the literature that the disposition effect is an implication of a prospect-theory type of individual preferences. I examine different potential explanations for the size dependence of the disposition effect, such as margin calls being triggered more often by the more volatile small stocks, different trading styles in small stocks and large stocks and different behavior with regard to small and large gains and losses. My findings are consistent with a view that individual beliefs rather than preferences are generating the disposition effect.
We provide evidence of private information in the foreign exchange market. The evidence comes from the introduction of trading in Tokyo over the lunch hour. Lunch-return variance doubles with the introduction of trading, which cannot be due to public information since the flow of public information did not change with the trading rules. We then exploit microstructure theory to discriminate between the two alternatives: private information and mispricing. Four key results support the predictions of private-information models. Three of these involve changes in the intraday volatility U-shape. The fourth is that opening trade causes mispricing's share in variance to fall.
We study equilibrium firm-level stock returns in two economies: one in which investors are loss averse over the fluctuations of their stock portfolio, and another in which they are loss averse over the fluctuations of individual stocks that they own. Both approaches can shed light on empirical phenomena, but we find the second approach to be more successful: In that economy, the typical individual stock return has a high mean and excess volatility, and there is a large value premium in the cross section which can, to some extent, be captured by a commonly used multifactor model.
This paper explains why seemingly irrational overconfident behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overconfident individuals (“entrepreneurs”) convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overconfidence, and on the accuracy of individuals' private information. The stationary distribution trades off the fitness of the group against the fitness of overconfident individuals.
This paper offers a model in which asset prices reflect both covariance risk and misperceptions of firms' prospects, and in which arbitrageurs trade against mispricing. In equilibrium, expected returns are linearly related to both risk and mispricing measures (e.g., fundamental/price ratios). With many securities, mispricing of idiosyncratic value components diminishes but systematic mispricing does not. The theory offers untested empirical implications about volume, volatility, fundamental/price ratios, and mean returns, and is consistent with several empirical findings. These include the ability of fundamental/price ratios and market value to forecast returns, and the domination of beta by these variables in some studies.
Recent research has proposed several ways in which overconfident traders can persist in competition with rational traders. This paper offers an additional reason: overconfident traders do better than purely rational traders at exploiting mispricing caused by liquidity or noise traders. We examine both the static profitability of overconfident versus rational trading strategies, and the dynamic evolution of a population of overconfident, rational and noise traders. Replication of overconfident and rational types is assumed to be increasing in the recent profitability of their strategies. The main result is that the long-run steady-state equilibrium always involves overconfident traders as a substantial positive fraction of the population.
The ‘disposition effect’ is the tendency to sell assets that have gained value (‘winners’) and keep assets that have lost value (‘losers’). Disposition effects can be explained by the two features of prospect theory: the idea that people value gains and losses relative to a reference point (the initial purchase price of shares), and the tendency to seek risk when faced with possible losses, and avoid risk when a certain gain is possible. Our experiments were designed to see if subjects would exhibit disposition effects. Subjects bought and sold shares in six risky assets. Asset prices fluctuated in each period. Contrary to Bayesian optimization, subjects did tend to sell winners and keep losers. When the shares were automatically sold after each period, the disposition effect was greatly reduced.
Theoretical models predict that overconfident investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997. We document that men trade 45 percent more than women. Trading reduces men's net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women. © 2000 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
We use futures transaction data to investigate cross-sectional relationships between market-maker inventory positions and
trade activity. The investigation documents strongly that traders control inventory throughout the trading day. Despite this
evidence of inventory management, typical inventory control models are contradicted by our data. These inventory models predict
that market-maker reservation prices are negatively influenced by inventory. Surprisingly, our evidence shows, as a strong
and consistent empirical regularity, that correlations between inventory and reservation prices are positive. We interpret
the evidence as consistent with active position taking by futures market floor traders.
Two behavioral concepts, loss aversion and mental accounting, have been combined to provide a theoretical explanation of the equity premium puzzle. Recent experimental evidence supports the theory, as students' behavior has been found to be consistent with myopic loss aversion (MLA). Yet, much like certain anomalies in the realm of riskless decision-making, these behavioral tendencies may be attenuated among professionals. Using traders recruited from the CBOT, we do indeed find behavioral differences between professionals and students, but rather than discovering that the anomaly is muted, we find that traders exhibit behavior consistent with MLA to a greater extent than students.
A unique data set allows us to monitor the buys, sells, and holds of individuals and institutions in the Finnish stock market on a daily basis. With this data set, we employ Logit regressions to identify the determinants of buying and selling activity over a two-year period. We find evidence that investors are reluctant to realize losses, that they engage in tax-loss selling activity, and that past returns and historical price patterns, such as being at a monthly high or low, affect trading. There also is modest evidence that life-cycle trading plays a role in the pattern of buys and sells. Copyright The American Finance Association 2001.
I test the disposition effect, the tendency of investors to hold losing investments too long and sell winning investments too soon, by analyzing trading records for 10,000 accounts at a large discount brokerage house. These investors demonstrate a strong preference for realizing winners rather than losers. Their behavior does not appear to be motivated by a desire to rebalance portfolios, or to avoid the higher trading costs of low priced stocks. Nor is it justified by subsequent portfolio performance. For taxable investments, it is suboptimal and leads to lower after-tax returns. Tax-motivated selling is most evident in December. Copyright The American Finance Association 1998.
Recent empirical research in finance has uncovered two families of pervasive regularities: underreaction of stock prices to news such as earnings announcements, and overreaction of stock prices to a series of good or bad news. In this paper, we present a parsimonious model of investor sentiment, or of how investors form beliefs, which is consistent with the empirical findings. The model is based on psychological evidence and produces both underreaction and overreaction for a wide range of parameter values.
This paper documents strong evidence for behavioral biases among Chicago Board of Trade proprietary traders and investigates the effect these biases have on prices. Our traders appear highly loss-averse, regularly assuming above-average afternoon risk to recover from morning losses. This behavior has important short-term consequences for afternoon prices, as losing traders actively purchase contracts at higher prices and sell contracts at lower prices than those that prevailed previously. However, the market appears to distinguish these risk-seeking trades from informed trading. Prices set by loss-averse traders are reversed significantly more quickly than those set by unbiased traders. Copyright 2005 by The American Finance Association.
The basic paradigm of asset pricing is in vibrant flux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both "risk" and "misvaluation". This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models. Copyright The American Finance Association 2001.
Analysis of decision making under risk has been dominated by expected utility theory, which generally accounts for people's actions. Presents a critique of expected utility theory as a descriptive model of decision making under risk, and argues that common forms of utility theory are not adequate, and proposes an alternative theory of choice under risk called prospect theory. In expected utility theory, utilities of outcomes are weighted by their probabilities. Considers results of responses to various hypothetical decision situations under risk and shows results that violate the tenets of expected utility theory. People overweight outcomes considered certain, relative to outcomes that are merely probable, a situation called the "certainty effect." This effect contributes to risk aversion in choices involving sure gains, and to risk seeking in choices involving sure losses. In choices where gains are replaced by losses, the pattern is called the "reflection effect." People discard components shared by all prospects under consideration, a tendency called the "isolation effect." Also shows that in choice situations, preferences may be altered by different representations of probabilities. Develops an alternative theory of individual decision making under risk, called prospect theory, developed for simple prospects with monetary outcomes and stated probabilities, in which value is given to gains and losses (i.e., changes in wealth or welfare) rather than to final assets, and probabilities are replaced by decision weights. The theory has two phases. The editing phase organizes and reformulates the options to simplify later evaluation and choice. The edited prospects are evaluated and the highest value prospect chosen. Discusses and models this theory, and offers directions for extending prospect theory are offered. (TNM)
Two behavioral concepts, loss aversion and mental accounting, have been combined to provide a theoretical explanation of the equity premium puzzle. Recent experimental evidence supports the theory, as students' behavior has been found to be consistent with myopic loss aversion (MLA). Yet, much like certain anomalies in the realm of riskless decision-making, these behavioral tendencies may be attenuated among professionals. Using traders recruited from the CBOT, we do indeed find behavioral differences between professionals and students, but rather than discovering that the anomaly is muted, we find that traders exhibit behavior consistent with MLA to a "greater" extent than students. Copyright 2005 by The American Finance Association.
This paper presents empirical evidence comparing two models of trading in equities—the well‐known tax‐loss‐selling hypothesis and “the disposition effect.” According to the disposition effect, investors are reluctant to realize losses but are eager to realize gains. This paper distinguishes between the two models with a new methodology that examines the relationship between volume at a given point in time and volume that took place in the past at different stock prices. The evidence overwhelmingly supports the disposition effect not only as a determinant of year‐end volume, but also as a determinant of volume levels throughout the year.
In this article, we consider misleading advertising and in particular the advertising of a false regular price when a bargain price is announced. To take into account the strategic interactions between firms and the consumers' rationality when confronted with advertising, we develop a duopoly model à la Bertrand in which equilibrium prices do transmit information on product quality. The use of false regular prices appears then as the transmission of an indirect and false information on the product quality. We derive and characterize the bargain price equilibrium when consumers make a rational use of prices (although they may still be misled at times) to infer product qualities. Hence the model captures essential aspects of markets with advertising: consumers are rational and firms are engaged in a strategic game with differentiated products. Nous considérons dans cet article la publicité trompeuse, et en particulier la publicité portant sur un faux prix régulier lorsqu’un prix d’aubaine est annoncé. Afin de prendre en considération les interactions stratégiques entre les firmes ainsi que la rationalité des consommateurs face à la publicité des entreprises, nous développons un modèle formel de duopole à la Bertrand dans lequel les prix transmettent à l’équilibre de l’information sur la qualité des produits. L’usage d’un faux prix régulier apparaît alors comme la transmission d’une information indirecte, et fausse, sur la qualité du produit. Nous dérivons et caractérisons un équilibre avec prix d’aubaine dans lequel les consommateurs font un usage rationnel de l’information sur les prix (tout en reconnaissant qu’ils peuvent être parfois trompés par une information incorrecte, inexacte ou frauduleuse) afin d’inférer les caractéristiques de qualité des produits. Le modèle possède ainsi les caractéristiques essentielles des marchés de publicité : d’une part les consommateurs sont rationnels et à l’équilibre ant
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.
We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy. Copyright The American Finance Association 1998.
This paper explains why seemingly irrational overconfident behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overconfident individuals ("entrepreneurs") convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades o# the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overconfidence, and on the accuracy of individuals' private information. The evolutionary stable proportion trades o# the survival of the group against the survival of overconfident individuals. # This paper (UCLA WP-9/97, May 16, 2000) is available from http://linux.anderson.ucla.edu/research.html. Common US mail address: Anderson Graduate School of Management, 110 Westwood Plaza, Box 951481, Los Angeles, CA 90095, Tel: (310) 825-2508. We are gratef...
Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that traded most earned an annual return of 11.4 percent, while the market returned 17.9 percent. The average household earned an annual return of 16.4 percent, tilted its common stock investment toward high-beta, small, value stocks, and turned over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth. 1 The investor's chief problem -- and even his worst enemy -- is likely to be himself. Benjamin Graham In 1996, approximately 47 percent of equity investments in the U.S. were held directly by households, 23 percent by pension funds, and 14 percent by mutual funds (Security Industry Fact Book, 1997). Financial economists have extensiv...
We propose a new framework for pricing assets, derived in part from the traditional consumption-based approach, but which also incorporates two long-standing ideas in psychology: the prospect theory of Kahneman and Tversky #1979#, and the evidence of Thaler and Johnson #1990# and others on the in#uence of prior outcomes on risky choice. Consistent with prospect theory, the investor in our model derives utility not only from consumption levels but also from changes in the value of his #nancial wealth. He is much more sensitive to reductions in wealth than to increases, the #loss-aversion# feature of prospect utility. Moreover, consistent with experimental evidence, the utility he receives from gains and losses in wealth depends on his prior investment outcomes; prior gains cushion subsequent losses # the so-called #house-money# e#ect # while prior losses intensify the pain of subsequent shortfalls. We study asset prices in the presence of agents with preferences of this ...