The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence
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. This is a key paper on the disposition effect.
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.
Source: http://faculty.chicagobooth.edu/george.constantinides/documents/JF_1985b.pdf
Hersh Shefrin and Meir Statman
The Journal of Finance
Vol. 40, No. 3, Papers and Proceedings of the Forty-Third Annual Meeting American Finance Association, Dallas, Texas, December 28-30, 1984 (Jul., 1985), pp. 777-790
(article consists of 14 pages)
Published by: Blackwell Publishing for the American Finance Association
Stable URL: http://www.jstor.org/stable/2327802
