Disposition Effect Literature Review
Disposition Effect
Research Project Management Skills
February 2011
By Emmanouil Kaldis,
Student: Emmanouil Kaldis 090043443
Subject: THE DISPOSITION EFFECT
Behavioral finance and stock trading: what does the empirical evidence tell us about the disposition effect?
INTRODUCTION.
One will think that when a stock is considered a winner the investor will be willing to hold this stock and try to get rid of the loser stocks. In contrast, studies have indicated that there is an anomaly affecting the investor’s behavior on stock trading. In Hersh Shefrin and Mein Statman’s report (1985) this anomaly is referred as a disposition effect and it is related to investors’ tendency on selling assets whose price has substantially increased too quickly but also holding losers too long. In other words, investors have a propensity to recognize gains while in the same time are less willing to recognize losses. Due to this fact, several papers have been published to illustrate the outcome the disposition effect has on several aspects of stock trading. Taking this in consideration, this paper focuses on the features of this effect in the extend of the angles these economists have presented their empirical evidence.
LITERATURE REVIEW Following the Prospect Theory raised by Amos Tversky and Daniel Kahneman (1986), Shefrin and Statman (1985) take a further step and try to examine the decisions that might have a crucial impact on the decision making on realizing gains and losses in a market setting. Through their empirical evidence they include elements such as mental accounting, self-control, regret aversion and tax consideration in order to perceive these results and widen the prospect theory. In addition, Shefrin and Statman (1985) taking into consideration the work of Constantinides(1985), who studied a strategic optimization of short term- gains and losses through US tax code, came up the December effect. Constantinides(1985) argued that the returns on an
Research Project Management Skills
February 2011
By Emmanouil Kaldis,
Student: Emmanouil Kaldis 090043443
Subject: THE DISPOSITION EFFECT
Behavioral finance and stock trading: what does the empirical evidence tell us about the disposition effect?
INTRODUCTION.
One will think that when a stock is considered a winner the investor will be willing to hold this stock and try to get rid of the loser stocks. In contrast, studies have indicated that there is an anomaly affecting the investor’s behavior on stock trading. In Hersh Shefrin and Mein Statman’s report (1985) this anomaly is referred as a disposition effect and it is related to investors’ tendency on selling assets whose price has substantially increased too quickly but also holding losers too long. In other words, investors have a propensity to recognize gains while in the same time are less willing to recognize losses. Due to this fact, several papers have been published to illustrate the outcome the disposition effect has on several aspects of stock trading. Taking this in consideration, this paper focuses on the features of this effect in the extend of the angles these economists have presented their empirical evidence.
LITERATURE REVIEW Following the Prospect Theory raised by Amos Tversky and Daniel Kahneman (1986), Shefrin and Statman (1985) take a further step and try to examine the decisions that might have a crucial impact on the decision making on realizing gains and losses in a market setting. Through their empirical evidence they include elements such as mental accounting, self-control, regret aversion and tax consideration in order to perceive these results and widen the prospect theory. In addition, Shefrin and Statman (1985) taking into consideration the work of Constantinides(1985), who studied a strategic optimization of short term- gains and losses through US tax code, came up the December effect. Constantinides(1985) argued that the returns on an
References: Frazini, A. (2006), "The Disposition Effect and Underreaction to News", The Journal of Finance, vol. I.XI, no. 4, pp. 217-2046 Seongyeon Lim, S Tversky, S. & Kahneman, D. (1986), "Rational Choice and the Framing of Decisions", The Journal of Business, part 2 : The behavioral Foundations of Economic Theory , vol. 59, no. 4, pp. S251-S278. Odean, T. & (1998), "Are investors Reluctant to Realize Their Losses?", The Journal of Finance, vol. 53, no. 5, pp. 1775-1798. Weber, M. & Camerer, C.F. (1998), "The disposition effect in securities trading: an experimental analysis", The Journal of Economic Behavior & Organization, vol. 33, pp. 167- 184 Coval, J.D Shefrin, H. & Statman, M. (1985), "The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence", The Journal of Finance, vol. 40, no. 3, pp. 777-790. Constantinides, G.M., & (1985), "The Disposition to Sell Winners Too Early and Ride Losers Too Long:Theory and Evidence: Discussion", The Journal of Finance, vol. 40, no. 3, pp. 791-792. Ferris, S.P., Haugen, R.A. & Makhija, A.K. (1987), "Predicting Contemporary Volume with Historic Volume at Diffential Price Levels: Evidence Supporting the Disposition effect", The Journal of Finance, vol. 43, no. 3, pp. 677-697. Locke, P.R., Mann, S.C. & (2005), "Professional traders discipline and trade disposition", The Journal of Financial Economics, vol. 76, no. 2, pp. 401-444. Kroll, Y. & Levy, H. (1992), "Further tests of the Separation Theorem and the Capital Asset Pricing Model", The American Economic Review, vol. 82, no. 3, pp. 664-670. Choe, H. & Eom, Y. (2006), "The disposition effect and investment Performance in the Future Market", Garvey, R Lakonishok, J. & Smidt, S. (1986), "Volume for Winners and Losers: Taxation and Other Motives for Stock Trading", The Journal of Finance, vol. 41, no. 4, pp. 951-974 Wermers, R., White, H