Do you have a choice?: Implications for belief updating and the disposition effect

The present paper evaluates the importance of belief updating for the prevalence of the disposition effect – the reluctance to sell assets at losses as compared to gains. In particular, the present paper studies whether restricting choices in investment risk taking decisions motivates different learning from the decision outcomes and whether such differences in learning cause differences in the emergence of the disposition effect. The results show that investors learn from negative outcomes more like Bayesians if their risk-taking decisions are restricted. Causal mediation analysis reveals that such differences in learning increases the probability to sell after losses, which improves the overall investment performance. Compared to gains, the differences in learning after losses explain also why investors making active risk-taking choices are less likely to sell after losses as compared to gains, while the effect is reversed when choices are restricted. These findings suggest that restricting the discretion in decisions influences the way investors learn from decision outcomes and these differences in learning can explain puzzling differences in the risk-taking behavior of individual investors.