When the disposition effect proves to be rational: Experimental evidence from professional traders

Abstract

The disposition effect is a behavioural finance anomaly that has been observed in many populations including non-professional investors as well as professional investors and has been linked to reduced trading performance. However, the majority of studies to date have looked at the disposition effect in the context of non-mean reverting markets. We conducted a within-subject experiment with n = 193 professional traders, to examine how the tendency towards the disposition effect varies across decision-making for mean reverting securities and non-mean reverting securities. In addition, we consider whether a simple informational intervention that makes the disposition effect salient can alter decision-making. Overall, we find that prior to the intervention the traders exhibit the disposition effect in the direction that aligns with profit maximisation goals suggesting that they are acting rational. For decisions on mean reverting securities the traders tend to make decisions in the direction of the disposition effect, which is rational given their mean reverting properties. We also find that the informational intervention is effective in changing the level of the disposition effect observed and decision-making, regardless of whether traders are considering decisions over mean reverting or non-mean reverting securities. Further, we provide evidence that our simple informational intervention improves trader returns when making decisions on non-mean reverting securities. In contrast, it has a negative impact when utilised for mean reverting securities. Our study highlights the power of simple interventions to make disproportionately large changes to decision-making regardless of whether they are in our best interests, and their beneficial role only when the context is right.

Information and context matter: debiasing the disposition effect with lasting impact

“…Similar to Guenther and Lordan (2023), the participants for Measurement 1 were put in a hypothetical trading situation and presented with a total of 14 candlestick charts of actual tradable stocks in random order (refer to Supplementary Figure S1 for an example). For each stock 50 trading periods (weeks) were displayed while the identity of the underlying stock was disguised.…”

“…Feedback has been shown to be a valuable tool to improve decision-making in various contexts (Ben-David et al, 2018). Furthermore, we are extending the study of Guenther and Lordan (2023) by shifting the focus from professional traders to retail investors. This alteration in the target population is made because retail investors, who generally have lower financial sophistication, are more vulnerable to trading biases (Dhar and Zhu, 2006;Chen et al, 2007) and would benefit from feedback.…”

“…Similarly, Guenther and Lordan (2023) showed that the disposition effect can be reduced among professional traders by presenting a related informational intervention about the existence of the disposition effect before traders make trading decisions. In their within-subject online study with n = 193 mostly UK-based Delegated asset refers to investment assets that investors delegate the day-to-day management to investment experts.…”

“…In contrast to Dobrich et al (2014) our study was conducted with UK residents-as opposed to German-speaking residents in Europe. In addition, we deploy a different experimental set-up from Guenther and Lordan (2023) as well as a slightly different framing of the intervention. Instead of simply providing information about the disposition effect, and its potential detrimental consequences of the disposition effect, we structure our intervention in a manner that appears to be personalized feedback to participants' previous behaviors.…”

“…Given the negative implications of the disposition effect on investment returns-in the absence of mean-reversion (Guenther and Lordan, 2023)-researchers have explored various debiasing strategies and interventions to mitigate the disposition effect (e.g., Weber and Camerer, 1998;Frydman and Rangel, 2014;Fischbacher et al, 2017). However, the majority of the studies have been conducted with student participants and-to the best of our knowledge-have not investigated whether their intervention has a lasting impact on decision making in the absence of the intervention.…”