Up Close and Personal: Investor Sophistication and the Disposition Effect

Abstract

This paper analyzes the trading records of a major discount brokerage house to investigate the disposition effect, the tendency to sell stocks that have appreciated in price (winners) sooner than stocks that trade below the purchase price (losers). In contrast to previous research that has demonstrated the disposition effect by aggregating across investors, our main objective is to identify differences in the disposition bias across individuals and explain this in terms of underlying investor characteristics. Building on the findings in experimental economics and social psychology, we hypothesize that differences in investor literacy about financial markets and trading frequency are responsible in part for the variation in individual disposition effect. Using demographic and socioeconomic variables as proxies for investor literacy, we find empirical evidence that wealthier individuals and individuals employed in professional occupations exhibit a lower disposition effect. Consistent with experimental economics, trading frequency also tends to reduce the disposition effect. We provide guidelines for investment advisors, regulators, and investment communities to utilize our findings and help investors make better decisions.disposition effect, investor sophistication, individual decision making

The disposition effect in team investment decisions: Experimental evidence

“…Summers and Duxbury (2012) demonstrate that emotional responses such as regret are a necessary cause of disposition effects. The effect is confirmed for private investors (Odean, 1998;Dhar and Zhu, 2006), professional traders (Ferris et al, 1988, Garvey andMurphy, 2004), house owners (Genesove and Mayer, 2001), and students (Weber and Camerer, 1998). Recent experiments have demonstrated that nudging approaches help to debias the disposition effect of individuals.…”

Financial literacy, financial advice, and financial behavior

“…4.1), several contributions lacking an observable measure of financial capabilities exploit this evidence and use respondents' demographics in order to capture their financial literacy. Corresponding proxies for financial sophistication used in the literature include (disposable) income and wealth (Dhar and Zhu 2006;Vissing-Jorgensen 2003;Calvet et al 2007Calvet et al , 2009) as well as age (Calvet et al 2007(Calvet et al , 2009Georgarakos and Pasini 2011), educational attainment (Christiansen et al 2008;Calvet et al 2007Calvet et al , 2009), professional status (Calvet et al 2009), and even IQ (Grinblatt et al 2011(Grinblatt et al , 2012. Likewise, both Chalmers and Reuter (2012) and Hackethal et al (2012) use subsets of these demographics to proxy for financial literacy in their analyses.…”

FinancialLiteracyand Satisfaction in Malaysia: A Pilot Study

“…The effectiveness of such programs have been evaluated through, among others, individuals" portfolio diversification [4], extents of the disposition effect [5] and retirement planning [6]. The main problem associated with low level of financial literacy is that individuals can suffer credit problems which may lead to bankruptcy.…”