Neural insensitivity to upticks in value is associated with the disposition effect

Abstract

The disposition effect is a phenomenon in which investors hold onto losing assets longer than they hold onto gaining assets. In this study, we used functional magnetic resonance imaging (fMRI) to measure the response of valuation regions in the brain during the decision to keep or to sell an asset that followed a random walk in price. The most common explanation for the disposition effect is preference-based: namely, that people are risk-averse over gains and risk-seeking over losses. This explanation would predict correlations between individuals’ risk-preferences, the magnitude of their disposition effect, and activation in valuation structures of the brain. We did not observe these correlations. Nor did we find evidence for a realization utility explanation, which would predict differential responses in valuation regions during the decision to sell versus keep an asset that correlated with the magnitude of the disposition effect. Instead, we found an attenuated ventral striatum response to upticks in value below the purchase price in some individuals with a large disposition effect. Given the role of the striatum in signaling prediction error, the blunted striatal response is consistent with the expectation that an asset will rise when it is below the purchase price, thus spurring loss-holding behavior. This suggests that for some individuals, the disposition effect is likely driven by a belief that the asset will eventually return to the purchase price, also known as mean reversion.

An ALE Meta-Analysis on Investment Decision-Making

“…Eight studies focused on certain cognitive processes while choosing between investments, including sunk costs [ 30 , 31 ], disposition effects [ 41 ] and prediction errors [ 36 , 42 , 43 ].…”

“…This is related to higher activation not only in the prefrontal and parietal cortices [ 29 , 30 , 31 ], but also in the anterior insula, due to its role in risky decision-making [ 29 , 32 ]. This latter brain area, along with the ventral striatum, has been repeatedly found to be active in tasks involving trading decisions [ 21 , 34 , 36 , 37 , 38 , 41 , 42 , 43 ].…”

“…Investment decisions can be affected by certain cognitive processes, such as higher sunk costs translating into more risk-taking behaviors in the lateral prefrontal and parietal cortices [ 30 , 31 ]; a higher disposition effect lowering ventral striatum activity because investors held onto losing assets longer [ 41 ]; fictive errors driving investment behavior through increased activity in the ventral striatum [ 36 , 43 ]; and decreased activity in anterior insula and anterior insula-amygdala connectivity when reappraisal strategies regulated negative feelings [ 42 ].…”

Psychophysiological Correlates of the Disposition Effect

“…For example, Brooks, Capra and Berns [7] find that for decisions below the purchase price, a greater disposition effect is correlated with a blunted ventral striatum response to upticks in value in some individuals. And activity in such brain region scales with both the expected and subjective value of stimuli.…”

Losers and prospectors in the short‐term options market

“…For instance, Ben‐David and Hirshleifer () are unable to link the biases among winning and losing stock traders to PT. Barberis and Xiong () and Brooks, Capra, and Berns () show that excessive risk‐taking may not predictably explain why losing stock traders hold out. They suggest that the appearance of holding‐out behavior of losers could actually be a manifestation of relatively conservative behavior, altogether unrelated to risk‐taking.…”