Application of Structural Equation Modeling in Behavioral Finance: A Study on the Disposition Effect

Studies on behavioral finance argue that cognitive/emotional biases could influence investors’ decisions and result in the disposition effect, wherein investors have the tendency to sell winning stocks too early and hold losing stocks too long. In this regard, this study proposes a conceptual model to examine the relationship among cognitive/emotional biases, the disposition effect, and investment performance. Cognitive/emotional biases mainly consist of mental accounting, regret avoidance, and self-control. Furthermore, this study examines whether gender and marital status moderate the relationship between these biases and the disposition effect by collecting quantitative data through a questionnaire survey and employing a structural equation modeling (SEM) approach to execute the estimation procedure. The results of this study show that mental accounting has the most significant influence on the disposition effect, which implies that prospect theory is an alternative to expected utility theory in accounting for investor’s behavior. The findings of moderating analysis indicate that female investors display a larger disposition effect than male investors.