The disposition effect is an anomaly discovered in behavioral finance. It relates to the tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value.
Investors are less willing to recognize losses (which they would be forced to do if they sold assets which had fallen in value), but are more willing to recognize gains. This is irrational behaviour, as the future performance of equity is unrelated to its purchase price. If anything, investors should be more likely to sell “losers” in order to exploit tax reductions on capital gains. In a study by Terrance Odean, this tax-motivated selling is only observed in December, the final opportunity to claim tax cuts by unloading losing stocks; in other months, the disposition effect is typically observed.
The disposition effect can be partially explained using loss aversion. More comprehensive explanations also use other aspects of prospect theory, such as reflection effect, or involve cognitive dissonance.
- Endowment effect
- Prospect theory
- Status quo bias
- Loss aversion
- sunk cost is a kind of disposition effect
- Cognitive dissonance
- The disposition effect: do New Zealand investors keep their mistakes? (PDF), 2000
- Camerer C.F. (2000) “Prospect theory in the wild: evidence from the field,” in Choices, values and frames, Kahneman D. & Tversky A. (eds), Russell Sage, New York and Cambridge University Press, Cambridge
- Barberis N. & Xiong W. (2009) “What drives the disposition effect? An analysis of a long-standing preference-based explanation,” The Journal of Finance, 64(2): 751-784
- Odean T. (1998) “Are investors reluctant to realize their losses?” The Journal of Finance, 53(5): 1775-1798
- Weber M. & Camerer C.F. (1998) “The disposition effect in securities trading: an experimental analysis,” Journal of Economic Behavior and Organization, 33(2): 167-184
- Shefrin H. & Statman M. (1985) “The disposition to sell winners too early and ride losers too long: theory and evidence,” The Journal of Finance, 40(3) Papers and Proceedings of the Forty-Third Annual Meeting American Finance Association, Dallas, Texas December 28-30, 1984: 777-790
- Frazzini A. (2006) “The disposition effect and underreaction to news,” The Journal of Finance, 61(4): 2017-2046
- What drives the disposition effect? (PDF), 2001
- Waning vigilance and the disposition effect: Evidence from Thailand on individual investor decision making (PDF), 2010
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