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Does the consciousness of the disposition effect increase the equity premium?

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  • Patrick Roger

    ()
    (Laboratoire de Recherche en Gestion et Economie, Université Louis Pasteur)

Abstract

The disposition effect is a well established phenomenon in the empirical and experimental financial literature. It leads to sell winners too early and to hold losers too long. In this paper, we show that the consciousness of the disposition effect by investors lead them to require a greater risk premium to invest in stocks (when compared to rational investors). We also analyze the role of the evaluation period for disposition investors. We show that the risk premium they require is a decreasing function of the delay between two evaluations of their portfolio. The influence of the evaluation period on the equity premium looks like the one induced by myopic loss aversion (Benartzi-Thaler, 1995) but the origin is different. Valuing more often a portfolio give more occasions to sell winning stocks and then decreases the expected return. This point is analyzed by assuming that returns are driven by a Brownian motion and that investors evaluate their portfolio at regularly spaced dates.

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Bibliographic Info

Paper provided by Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg in its series Working Papers of LaRGE Research Center with number 2007-01.

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Date of creation: 2007
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Handle: RePEc:lar:wpaper:2007-01

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Keywords: Disposition effect; equity premium puzzle; loss aversion; behavioral finance.;

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  1. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  2. David Genesove & Christopher Mayer, . "Loss Aversion and Seller Behavior: Evidence from the Housing Market," Zell/Lurie Center Working Papers 323, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania.
  3. Lakonishok, Josef & Smidt, Seymour, 1986. " Volume for Winners and Losers: Taxation and Other Motives for Stock Trading," Journal of Finance, American Finance Association, vol. 41(4), pages 951-74, September.
  4. Grinblatt, Mark & Keloharju, Matti, 2000. "The investment behavior and performance of various investor types: a study of Finland's unique data set," Journal of Financial Economics, Elsevier, vol. 55(1), pages 43-67, January.
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  6. Philip Brown & Nick Chappel & Ray Da Silva Rosa & Terry Walter, 2006. "The Reach of the Disposition Effect: Large Sample Evidence Across Investor Classes-super-," International Review of Finance, International Review of Finance Ltd., vol. 6(1-2), pages 43-78.
  7. Mark Grinblatt, 2001. "What Makes Investors Trade?," Journal of Finance, American Finance Association, vol. 56(2), pages 589-616, 04.
  8. Groot, J.S. de & Dijkstra, T.K., 1996. "The equity premium puzzle and the resolution by 'myopic loss aversion' revisited," Research Report 96E27, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  9. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  10. Weber, Martin & Camerer, Colin F., 1998. "The disposition effect in securities trading: an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 167-184, January.
  11. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  12. Nicholas Barberis & Wei Xiong, 2006. "What Drives the Disposition Effect? An Analysis of a Long-Standing Preference-Based Explanation," NBER Working Papers 12397, National Bureau of Economic Research, Inc.
  13. Joshua D. Coval & Tyler Shumway, 2005. "Do Behavioral Biases Affect Prices?," Journal of Finance, American Finance Association, vol. 60(1), pages 1-34, 02.
  14. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  15. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  16. Haliassos, Michael & Bertaut, Carol C, 1995. "Why Do So Few Hold Stocks?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1110-29, September.
  17. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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