Disposition effect

Abstract: 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. THE TENDENCY TO HOLD LOSERS too long and sell winners too soon has been labeled the disposition effect by Shefrin and Statman ~1985!. For taxable investments the disposition effect predicts that people will behave quite differently than they would if they paid attention to tax consequences. To test the disposition effect, I obtained the trading records from 1987 through 1993 for 10,000 accounts at a large discount brokerage house. An analysis of these records shows that, overall, investors realize their gains more readily than their losses. The analysis also indicates that many investors engage in taxmotivated selling, especially in December. Alternative explanations have been proposed for why investors might realize their profitable investments while retaining their losing investments. Investors may rationally, or irrationally, believe that their current losers will in the future outperform their current

Abstract: 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 trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent. The average household earns an annual return of 16.4 percent, tilts its common stock investment toward high-beta, small, value stocks, and turns 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.

Abstract: 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. IT HAS BEEN WELL-KNOWN for over thirty years that individual decision makers do not behave in accordance with the axioms of expected utility theory. The famous Allais paradoxes [1] have made this point abundantly clear. Recent work by Kahneman and Tversky [15], Machina [19], and others has sought to provide a theory which describes how decision makers actually behave when confronted with choice under uncertainty. One of the key findings by Kahneman and Tversky concerns decision makers whose recent gambling history reflects losses. They indicate that their analysis suggests that a person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise (p. 287). Kahneman and Tversky's finding was obtained in a controlled experimental situation. Economists tend to treat experimental evidence with some caution and are reluctant to conclude automatically that similar features will be exhibited in real-world market settings. Indeed, it is important to look at market behavior in order to ascertain whether such behavior patterns can be discerned in actual trading. In this paper, we examine decisions to realize gains and losses in a market setting. Specifically, we focus attention on financial markets and seek to determine whether investors exhibit a reluctance to realize losses (disposition to "ride

Abstract: 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. (This abstract was borrowed from another version of this item.)