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Reference Points Driven Investors' Demand, Disposition Effect and Momentum in Stock Returns

Author

Listed:
  • Enrico G. De Giorgi

    (University of St. Gallen - SEPS: Economics and Political Sciences; Swiss Finance Institute)

  • Dominik Kachel

    (University of St.Gallen)

  • Robert Leitner

    (University of St. Gallen)

Abstract

This paper develops a market model to analyze portfolio decisions and asset pricing implications of cumulative prospect theory preferences (Kahneman and Tversky 1979; Tversky and Kahneman 1992) when the reference point is dynamic and stochastic. We show that in the proposed framework, an asymmetric adaptation of reference aspiration levels after gains and losses is a necessary condition to obtain the disposition effect. Moreover, the model implies that at equilibrium, the equity premium reflects investors' expectations about their future reference adjustment. We test whether the conditions on the reference-point dynamics that imply the disposition effect also help explain market characteristics such as momentum and short-term reversals. We provide empirical evidence that supporting this hypothesis.

Suggested Citation

  • Enrico G. De Giorgi & Dominik Kachel & Robert Leitner, 2026. "Reference Points Driven Investors' Demand, Disposition Effect and Momentum in Stock Returns," Swiss Finance Institute Research Paper Series 26-23, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2623
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    File URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=6205178
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G40 - Financial Economics - - Behavioral Finance - - - General

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