This study examines whether the disposition effect (DE), i.e., the tendency of investors to ride losses and realize gains, exists in the Korean stock index futures market. Using a unique database, we find strong evidence for the DE and explain this in terms of investor characteristics. We also investigate the effect that the disposition bias has on investment performance. There are four main findings. First, individual investors are much more susceptible to the DE than institutional and foreign investors. Second, sophistication and trading experience tend to reduce the DE. Third, the DE is stronger in long positions than in short positions. Finally, there is a negative relationship between the DE and investment performance. This result is consistent with Odean (1998, Journal of Finance, 53, 1775-1798), but contrasts with Locke and Mann (2005, Journal of Financial Economics, 76, 401-444) who find no evidence of any contemporaneous measurable costs associated with the DE.It is known that participants in various markets exhibit other types of behavioral biases. Heath, Huddart, and Lang (1999) investigate the option-exercising behavior, and Poteshman and Serbin (2003) analyze the rationality of early exercises on the Chicago Board Options Exchange. Genesove and Mayer (2001) shed further light on investor irrationality by analyzing loss aversion and seller behavior in the housing market, and O'Connell and Teo (2003) analyze the trading decisions of institutional investors in the currency market.
To analyze the negative momentum profit in Korea, we further divide the decomposition of Lo and MacKinlay (1990) into winners' and losers' auto-and cross-serial covariances. We find that the negative autocovariance and the positive cross-serial covariance in Lo and MacKinlay's decomposition are asymmetric between winners and losers. The negative autocovariance is mainly from losers and the positive cross-serial covariance mainly between past winners and current losers. By investigating time-series characteristics of auto-(cross-serial) covariances, we cannot observe any systematic change of auto-(crossserial) covariances in the momentum period. Based upon the evidence in this paper, we argue that positive cross-serial covariance between past winners and current losers seems to be an important driving force behind the negative momentum profit in Korea. Therefore, investors' underreaction to market-wide information would be plausible explanation of the negative momentum profit.
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