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Disposition effect as a behavioral trading activity elicited by investors' different risk preferences

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  • Shoji, Isao
  • Kanehiro, Sumei

Abstract

This paper draws on numerical simulations to discuss the mechanism driving the disposition effect. The computational model is constructed from the basic ideas of prospect theory. The objective (or crude) rewards, obtained from investment, are transformed into subjective rewards via the value function proposed by prospect theory, which characterizes risk-aversion in gains and risk-seeking in losses. The optimal action is then chosen by maximizing the expected value of future subjective rewards. The results of numerical simulations of a finite-period optimal investment problem show that the disposition effect is given as its optimal solution, where the risk-seeking in losses is considered to play a key role in driving the effect.

Suggested Citation

  • Shoji, Isao & Kanehiro, Sumei, 2016. "Disposition effect as a behavioral trading activity elicited by investors' different risk preferences," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 104-112.
    • Handle: RePEc:eee:finana:v:46:y:2016:i:c:p:104-112
    DOI: 10.1016/j.irfa.2016.03.017
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    References listed on IDEAS

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    1. Nicholas Barberis & Wei Xiong, 2009. "What Drives the Disposition Effect? An Analysis of a Long‐Standing Preference‐Based Explanation," Journal of Finance, American Finance Association, vol. 64(2), pages 751-784, April.
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    Cited by:

    1. Hincapié-Salazar, Juliana & Agudelo, Diego A., 2020. "Is the disposition effect in bonds as strong as in stocks? Evidence from an emerging market," Global Finance Journal, Elsevier, vol. 46(C).

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    More about this item

    Keywords

    Disposition effect; Prospect theory; Different risk preference; Impulsivity for reward;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • D87 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Neuroeconomics
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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