The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence

Abstract

One of the most significant and unique features in Kahneman and Tversky's approach to choice under uncertainty is aversion to loss realization. This paper is concerned with two aspects of this feature. First, we place this behavior pattern into a wider theoretical framework concerning a general disposition to sell winners too early and hold losers too long. This framework includes other elements, namely mental accounting, regret aversion, self‐control, and tax considerations. Second, we discuss evidence which suggests that tax considerations alone cannot explain the observed patterns of loss and gain realization, and that the patterns are consistent with a combined effect of tax considerations and the three other elements of our framework. We also show that the concentration of loss realizations in December is not consistent with fully rational behavior, but is consistent with our theory.

Media Content and Stock Returns: The Predictive Power of Press

“…These results find support from the literature, as in Grossman and Stiglitz (1980), who find that the underreaction to negative news provides motivation for market participants to monitor financial news releases. The evidence of this underreaction to negative news also has a behavioural explanation (see Shefrin and Statman, 1985;Barberis, Shleifer, and Vishny, 1998;and Frazzini 2006). As with the case of positive news, we see significant return reversals in the subsequent trading days, with all of the effects coming from a significant reversal in lag 5.…”

Behavioral Finance: Advances in the Last Decade

“…The seminal work by Shefrin and Statman (1985) was the first to connect the disposition effect to psychological arguments. In particular, Shefrin and Statman showed that this phenomenon could be explained by the prospect theory offered by Kahneman and Tversky (1979), complemented by other psychological traits, such as regret aversion.…”

Do Investment Flows Drive the Disposition Effect on Fund Managers?

“…As Kahneman and Tversky (1979) posit that investors tend to be risk-averse when they profit and risk-taking when they have losses, the empirical evidence for aggregate individual data in securities trading also examined by Shefrin and Statman (1985) and Odean (1998). On the other hand, Dhar and Zhu (2006) examine the difference of DE across individual investors, they display the magnitude of DE is correlated with the investors' literacy level and trading frequency.…”

“…A number of papers in experimental studies provide evidence of tax-loss hypothesis, which suggests that investors, especially tax-sensitive investors, delay selling of stock holdings with high capital gain, e.g. Shefrin and Statman (1985), Odean (1998), Grinblatt and Keloharju (2001), Bergstresser and Poterba (2002), and Li (2006). To explore this issue of the tax sensitivity to fund's gains, we calculate each fund's value-weighted capital gain overhang on the basis of the market value of share holding to proxy for the tax gain overhang, denoted as TAXOVER.…”

“…Highly volatile flow might cause significant damage to a fund's finances, with an extreme example being Long-Term Capital Management Company (LTCM), which collapsed may be attributed to selling winning and high liquidity stocks in order to meet redemption demand. The phenomena of selling winners and riding losers, the so called DE, was introduced by Shefrin and Statman (1985) with regard to security trading, and was applied in the analysis for a great number of individual accounts by Odean (1998). The evidence shows that investors are risk taking when they have profits and risk averse when they have losses.…”