Disposition Effect
The disposition effect is an anomaly discovered in behavioral finance. It relates to the tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value. Investors are less willing to recognize losses (which they would be forced to do if they sold assets which had fallen in value), but are more willing to recognize gains.
The ‘disposition effect’ has four major elements:
- The prospect theory
- Mental accounting
- Regret aversion
- Self-control
Quotes from writings on the disposition effect:
‘The second paper, by Meir Statman and me, applied Kahneman and Tversky’s notion of framing to the realization of loses. We called this phenomenon the disposition effect, arguing that investors are predisposed to holding losers too long and selling winners too early.’
Shefrin (2000), page 8
Avoiding regret and seeking pride affects people’s behavior, but how does it affect investment decisions? This is called the disposition effect.
Nofsinger (2001) page 47
