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Is the disposition effect related to investors’ reliance on System 1 and System 2 processes or their strategy of emotion regulation?

Author

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  • Richards, Daniel W.
  • Fenton-O'Creevy, Mark
  • Rutterford, Janette
  • Kodwani, Devendra G.

Abstract

We report research on investor susceptibility to the disposition effect, a financial decision-making bias where investors have a greater propensity to realize gains than realize losses. Despite theoretical arguments for the influence of emotions, research on susceptibility to this bias, on real investors, has relied primarily on socio-demographic explanations. Some experimental research on student populations has considered emotions more directly, but has not addressed differences in individual susceptibility and has not examined genuinely consequential investor behaviour in real markets. Our research addresses this gap by predicting susceptibility to the disposition effect based on investors’ reliance on intuitive (emotion mediated) cognition (System 1), analytical cognition (System 2) and the strategies they use to regulate their emotions. Using investors’ trading records from a UK sample, we measure their susceptibility to the disposition effect and assess, through a questionnaire, their reliance on Systems 1 and 2 cognitive processes and use of two emotion regulation strategies. Investors with higher reliance on System 1 processes have greater disposition effect, but reliance on System 2 processes is not related to the disposition effect. Investor reliance on reappraisal (an emotion regulation strategy of changing a situation’s meaning to alter its emotional impact) reduces their disposition effect. However, the use of expressive suppression (a strategy that inhibits emotion expressive behaviour) does not show a statistically significant relationship with this bias. These results suggest that investors’ intuitive emotional reactions explain susceptibility to bias, and that effective strategies of regulating emotions enable this bias to be overcome.

Suggested Citation

  • Richards, Daniel W. & Fenton-O'Creevy, Mark & Rutterford, Janette & Kodwani, Devendra G., 2018. "Is the disposition effect related to investors’ reliance on System 1 and System 2 processes or their strategy of emotion regulation?," Journal of Economic Psychology, Elsevier, vol. 66(C), pages 79-92.
    • Handle: RePEc:eee:joepsy:v:66:y:2018:i:c:p:79-92
    DOI: 10.1016/j.joep.2018.01.003
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    Cited by:

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    2. Juan Carlos Matallín‐Sáez & Amparo Soler‐Domínguez & Salvador Navarro‐Montoliu & Diego Víctor de Mingo‐López, 2022. "Investor behavior and the demand for conventional and socially responsible mutual funds," Corporate Social Responsibility and Environmental Management, John Wiley & Sons, vol. 29(1), pages 46-59, January.
    3. Bachmann, Kremena, 2024. "Do you have a choice?: Implications for belief updating and the disposition effect," Journal of Economic Psychology, Elsevier, vol. 102(C).
    4. Hermann, Daniel & Mußhoff, Oliver & Rau, Holger A., 2019. "The disposition effect when deciding on behalf of others," Journal of Economic Psychology, Elsevier, vol. 74(C).
    5. Cao, Qian & Li, Jianbiao & Niu, Xiaofei, 2022. "Tempus fugit: The impact of time constraint on investor behavior," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 67-81.
    6. Rahmani, Djamel & Loureiro, Maria & Escobar, Cristina & Gil, José M., 2021. "How Emotions Affect Choices: The Case of Wine," 2021 Conference, August 17-31, 2021, Virtual 314943, International Association of Agricultural Economists.
    7. Liêu, L.M. & Pelster, M., 2020. "Framing and the disposition effect in a scopic regime," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 175-185.
    8. Richards, Daniel W. & Willows, Gizelle D., 2019. "Monday mornings: Individual investor trading on days of the week and times within a day," Journal of Behavioral and Experimental Finance, Elsevier, vol. 22(C), pages 105-115.
    9. Niu, Xiaofei & Li, Jianbiao, 2019. "How Time Constraint Affects the Disposition Effect?," EconStor Preprints 194618, ZBW - Leibniz Information Centre for Economics.
    10. Li, Jianbiao & Niu, Xiaofei & Li, Dahui & Cao, Qian, 2018. "Using Non-Invasive Brain Stimulation to Test the Role of Self-Control in Investor Behavior," EconStor Preprints 177890, ZBW - Leibniz Information Centre for Economics.

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    More about this item

    Keywords

    Disposition effect; Dual-process theory; Emotion regulation; Financial decision-making bias; Behavioral finance;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D1 - Microeconomics - - Household Behavior
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G2 - Financial Economics - - Financial Institutions and Services

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