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Human vs. Machine: Disposition Effect Among Algorithmic and Human Day-traders

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  • Karolis Liaudinskas

Abstract

Can humans achieve rationality, as defined by the expected utility theory, by automating their decision making? We use millisecond-stamped transaction-level data from the Copenhagen Stock Exchange to estimate the disposition effect – the tendency to sell winning but not losing stocks – among algorithmic and human professional day-traders. We find that: (1) the disposition effect is substantial among humans but virtually zero among algorithms; (2) this difference is not fully explained by rational explanations and is, at least partially, attributed to prospect theory, realization utility and beliefs in mean-reversion; (3) the disposition effect harms trading performance, which further deems such behavior irrational.

Suggested Citation

  • Karolis Liaudinskas, 2019. "Human vs. Machine: Disposition Effect Among Algorithmic and Human Day-traders," Working Papers 1133, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:1133
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    References listed on IDEAS

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    More about this item

    Keywords

    disposition effect; algorithmic trading; financial markets; rationality; automation;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • O3 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights

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