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The Disposition Effect and Underreaction to News

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  • ANDREA FRAZZINI

Abstract

This paper tests whether the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post‐announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event‐driven strategy based on this effect yields monthly alphas of over 200 basis points.

Suggested Citation

  • Andrea Frazzini, 2006. "The Disposition Effect and Underreaction to News," Journal of Finance, American Finance Association, vol. 61(4), pages 2017-2046, August.
    • Handle: RePEc:bla:jfinan:v:61:y:2006:i:4:p:2017-2046
    DOI: 10.1111/j.1540-6261.2006.00896.x
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