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Disposition Effect and Loss Aversion: An Analysis Based on a Simulated Experimental Stock Market

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Author Info

  • Kohsaka Youki

    ()
    (Center for Finance Research, Waseda University)

  • Grzegorz Mardyla

    ()
    (Faculty of Economics, Kinki University)

  • Shinji Takenaka

    ()
    (Japan Center for Economic Research)

  • Yoshiro Tsutsui

    ()
    (Graduate School of Economics, Osaka University)

Abstract

We experimentally investigate the existence of the disposition effect and loss aversion as its potential cause. Our approach includes three key characteristics: (i) An environment closely mimicking actual stock markets; (ii) Individual-specific reference prices; (iii) A direct test of loss aversion as a cause of the disposition effect. We find strong support for the existence of the disposition effect as an independent hypothesis. This is an improvement over previous studies, which tested this hypothesis only jointly with others. Our results also strongly point to loss aversion, of the type postulated by prospect theory, being a source of the disposition effect.

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Bibliographic Info

Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 13-02-Rev.

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Length: 38 pages
Date of creation: Feb 2013
Date of revision: Apr 2013
Handle: RePEc:osk:wpaper:1302r

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Web page: http://www.econ.osaka-u.ac.jp/
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Keywords: disposition effect; loss aversion; investor behavior; experimental economics;

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  1. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
  2. Kaustia, Markku, 2010. "Prospect Theory and the Disposition Effect," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(03), pages 791-812, June.
  3. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  4. 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.
  5. Constantinides, George M., 1984. "Optimal stock trading with personal taxes : Implications for prices and the abnormal January returns," Journal of Financial Economics, Elsevier, vol. 13(1), pages 65-89, March.
  6. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, vol. 53(5), pages 1775-1798, October.
  7. Erich Kirchler & Boris Maciejovsky & Martin Weber, 2004. "Framing Effects, Selective Information and Market Behavior ­ An Experimental Analysis ­," Papers on Strategic Interaction 2004-16, Max Planck Institute of Economics, Strategic Interaction Group.
  8. 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.
  9. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  10. Shefrin, Hersh & Statman, Meir, 1985. " The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, vol. 40(3), pages 777-90, July.
  11. Cramer, J. S. & Hartog, J. & Jonker, N. & Van Praag, C. M., 2002. "Low risk aversion encourages the choice for entrepreneurship: an empirical test of a truism," Journal of Economic Behavior & Organization, Elsevier, vol. 48(1), pages 29-36, May.
  12. 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.
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