Disposition Effect Bias

Investor portfolios are mainly concentrated in funds with low volatility in several markets and real estate funds, and 90% of assets are real estate investment funds, although the largest positions are held by funds with several markets. A study by Odean and Barber (1999) found that brokerage investors trade too much – detrimental gains – and tend to sell winners and keep losers (disposition effect). One of the main researchers on the topic, Terrence Odean of the Haas Business School, published results that show that “investors with discounted brokerage accounts in the United States sold winners more easily than losers, in line with investor emotional bias. United States: Loss aversion and cognitive bias in the belief that winners and losers will return to the mean. [Sources: 3, 14]

This bias occurs when an investor holds losses for too long by selling assets too quickly after making a profit. The disposition effect is a behavioral bias based on the idea that investors are unwilling to incur losses. This refers to the tendency of investors to sell assets that have risen in value while maintaining assets that have fallen in value. Alexander Joshi summed up the disposition effect as an arrangement that investors must hold in order to lose positions longer than winners, saying that investors will exemplify risk-taking by holding back losers because they don’t like losses and are afraid to prevent them. [Sources: 1, 4, 8]

Or, investors may wish to freeze funds to avoid the risk of selling the winner. Dacey and Zielonka showed that despite the disposal effect, the greater the volatility of stock prices, the greater the likelihood that investors will sell losers. The disposal effect refers to the tendency of investors to sell profitable stocks prematurely and to continue losing stocks for too long (Shefrin & Statman, 1985). The disposal effect refers to the tendency of investors to sell winners prematurely and keep losers for too long. This is one of the most well-documented and reliable decision-making biases. [Sources: 4, 7]

The disposition effect revolves around the view that investors have an emotional bias towards loss aversion. The rational and emotional responses that lead investors to practice disposal effects have much in common with another type of prejudice—loss aversion. The alienation effect has been described as one of the strongest realities for individual investors, because investors hold depreciated stocks but sell appreciation stocks. The order effect describes how investors often sell stocks that have risen in value when they can hold stocks in the hope of obtaining higher returns. [Sources: 2, 4, 14]

Investors tend to sell assets that have brought them positive returns and are reluctant to let go of those that have brought them losses. In addition, this article notes that seasoned investors are more likely to sell winning assets and contain losses. [Sources: 3, 13]

This document calculates the proportion of realized profits and the proportion of realized losses to see if investors are suffering from the alienation effect. An alternative way to study the alienation effect is to take into account that realized / paper gains and losses are independent not at the transaction level, but at the account or investor level [13]. The alienation effect relates to the way investors tend to view unrealized gains and losses on financial assets. [Sources: 3, 6, 9]

However, many studies have shown that when rebalancing and stock prices are checked, there is still a disposition effect and that investments that investors choose to sell continue into the following months to outpace the losers they own [cf. Odean (1998). , Brown et al. Regardless of the argument used, rational or behavioral, the presence of a disposition effect means that investors (individuals or institutions) will not receive optimal returns. Among the arguments that provide behavioral reasons for explaining the effect of disposition, the former predicts that investors have a value function, as argued by prospectus theory. Likewise, investors exhibit the opposite effect of disposition when they perceive their investments as progress towards a specific investment goal rather than an overall investment. [Sources: 1, 4, 9]

Compared to this level of analysis, Dhar and Zhu (2006) confirm a significant disposition effect on average, but show that a fifth of investors exhibit opposite behavior and that the disposition effect is stronger for less experienced investors. This article provides evidence that risk averse investors are more prone to the predisposition effect, males are less prone to this cognitive bias, and age is not associated with the predisposition effect. This article shows that gender is an important trait in understanding cognitive biases and that an investor’s experience may not necessarily be a factor in softening an investor’s position in a liquidity-constrained market. [Sources: 3, 9]

Previous research has mainly focused on the influence of demographic characteristics (eg, age, gender), investor preferences (eg, trading frequency), and trading environment (eg, the importance of information about the purchase price of a security) on the effect of disposition (Taylor and Ogilvy). , 1994; Chen et al. 2007; Da Costa et al., 2008). Our findings provide invaluable guidance for individual investors in making financial decisions based on their characteristics. Journal of Finance, 53 (5), 1775-1798. argues that the reasons for the disposition effect are more consistent with the behavioral arguments, as his research showed that even when all of the arguments listed earlier are under control, investors still exhibit a disposition effect. A corollary of this logic is that the consistency of past performance acts as a fundamental incentive to effectively realize a gain or loss if a return to mean bias affects the manager’s decision-making process. [Sources: 1, 7]

The constant (beta0) measures the investor’s propensity to sell stocks at a loss, and the sum of the constant plus the profit rate (beta0 + beta1) measures the investor’s propensity to sell stocks at a loss. Profit is a dummy variable. If the weighted average purchase price of stock j is less than the current market price of stock j, then this variable is equal to 1, otherwise equal to 0. Sale is a dummy variable. If the amount of asset j in the investor’s account decreases between the previous month and today, it is equal to 1, otherwise it is equal to 0. [Sources: 13]

This table contains the date (first column) when at least one of the two investors opened a position (buy or sell). The results in the second group (SRD) and the third group (warrants) in Table 7 show that these four groups are prone to bias, and for experienced traders, the disposal effect seems to be slightly lower (for SRD investors) DE is 0.045, for investors it is 0.043). For inexperienced investors, the warrants are 0.051 and 0.055 respectively). [Sources: 9]

Taken together, these results indicate that FSE can promote both risk-taking in the area of ​​losses and risk-aversion in the area of ​​profit, resulting in a greater willingness to sell winning stocks too early and hold on to losing stocks too long. For example, [9, 10, 12, 15] explains social interaction as a way of social control and finds that it enhances the disposition effect because investors want to preserve their reputation by postponing recognition of losses when their transactions are open to others. Overall, this paper suggests that social trading platforms can play a positive role in helping investors make better decisions. [Sources: 5, 7]


— Slimane Zouggari


##### Sources #####

[0]: https://www.investopedia.com/terms/b/bias.asp

[1]: https://www.scielo.br/scielo.php?script=sci_arttext&pid=S0034-75902015000100026

[2]: https://capital.com/disposition-effect-an-anomaly-in-behavioural-finance

[3]: https://www.emerald.com/insight/content/doi/10.1108/RAUSP-08-2019-0164/full/html

[4]: https://en.wikipedia.org/wiki/Disposition_effect

[5]: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7877604/

[6]: https://breakingdownfinance.com/finance-topics/behavioral-finance/disposition-effect/

[7]: https://www.frontiersin.org/articles/10.3389/fpsyg.2018.02705/full

[8]: https://www.nature.com/articles/s41598-021-02596-2

[9]: https://www.cairn.info/revue-finance-2009-1-page-51.htm

[10]: https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/disposition-effect/

[11]: https://www.pbs.org/wgbh/nova/money/disposition.html

[12]: https://www.sciencedirect.com/science/article/pii/S0927539819300623

[13]: https://www.sr-sv.com/understanding-the-disposition-effect/

[14]: https://www.wrapmanager.com/wealth-management-blog/what-investors-need-to-know-about-the-disposition-effect