Up Close and Personal: Investor Sophistication and the Disposition Effect
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.
Volume (Year): 52 (2006)
Issue (Month): 5 (May)
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