The disposition effect and investment performance in the futures market

Abstract

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.

Asymmetric Mispricing and Regime‐dependent Dynamics in Futures and Options Markets

“…The active participation of domestic individual investors makes the KOSPI200 futures and options markets more liquid and attractive. However, it can also make the markets more speculative and vulnerable to behavioral biases as individual investors are more likely than their institutional counterparts to be affected by investor psychology and market sentiments (Choe and Eom, 2009;Han et al, 2015;Kim and Ryu, 2015a;Kim et al, 2015). Therefore, these markets have a higher potential for mispricing and short-term disequilibrium in comparison to other developed markets.…”

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

“…There is robust field evidence that investors sell shares of stock significantly more often after an increase in the value of the shares, than they do after a decrease in value (Choe and Eom, 2009; Ferris et al, 1988; Grinblatt and Keloharju, 2001; Odean, 1998). This occurs despite the behavior being suboptimal in terms of profit earning (Choe and Eom, 2009; Odean, 1998).…”

“…There is robust field evidence that investors sell shares of stock significantly more often after an increase in the value of the shares, than they do after a decrease in value (Choe and Eom, 2009; Ferris et al, 1988; Grinblatt and Keloharju, 2001; Odean, 1998). This occurs despite the behavior being suboptimal in terms of profit earning (Choe and Eom, 2009; Odean, 1998). In experimental settings, where complex market forces are not present and participants are not experienced investors, the disposition effect still exists (Da Costa et al, 2008; Vlcek and Wang, 2008; Weber and Camerer, 1998).…”

Accounting Conservatism and Disposition Effect

“…And the disposition effect exists not only in the stock market, but also in employee stock options (Chen, Kim, Nofsinger et al 2007), the real estate market (Hyuk and Yunsung, 2009) as well as stock index futures market (Heath, Huddart and Lang, 1999). Barberis, Huang and Santos (2001) indicate that in the market prevailing investors subject to the prospect theory, the stock has a higher average rate of return and volatility, which indicates that the non-rational behavior will cause market volatilities and stock price bubbles.…”