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When the disposition effect proves to be rational: experimental evidence from professional traders

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Listed:
  • Guenther, Benno
  • Lordan, Grace

Abstract

The disposition effect is a behavioural finance anomaly that has been observed in many populations including non-professional investors as well as professional investors and has been linked to reduced trading performance. However, the majority of studies to date have looked at the disposition effect in the context of non-mean reverting markets. We conducted a within-subject experiment with n = 193 professional traders, to examine how the tendency towards the disposition effect varies across decision-making for mean reverting securities and non-mean reverting securities. In addition, we consider whether a simple informational intervention that makes the disposition effect salient can alter decision-making. Overall, we find that prior to the intervention the traders exhibit the disposition effect in the direction that aligns with profit maximisation goals suggesting that they are acting rational. For decisions on mean reverting securities the traders tend to make decisions in the direction of the disposition effect, which is rational given their mean reverting properties. We also find that the informational intervention is effective in changing the level of the disposition effect observed and decision-making, regardless of whether traders are considering decisions over mean reverting or non-mean reverting securities. Further, we provide evidence that our simple informational intervention improves trader returns when making decisions on non-mean reverting securities. In contrast, it has a negative impact when utilised for mean reverting securities. Our study highlights the power of simple interventions to make disproportionately large changes to decision-making regardless of whether they are in our best interests, and their beneficial role only when the context is right.

Suggested Citation

  • Guenther, Benno & Lordan, Grace, 2023. "When the disposition effect proves to be rational: experimental evidence from professional traders," LSE Research Online Documents on Economics 118353, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:118353
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    File URL: http://eprints.lse.ac.uk/118353/
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    References listed on IDEAS

    as
    1. Mark Grinblatt & Matti Keloharju, 2001. "What Makes Investors Trade?," Journal of Finance, American Finance Association, vol. 56(2), pages 589-616, April.
    2. repec:cup:judgdm:v:12:y:2017:i:2:p:118-127 is not listed on IDEAS
    3. Corneille, Olivier & De Winne, Rudy & D’Hondt, Catherine, 2018. "The disposition effect does not survive disclosure of expected price trends," Journal of Behavioral and Experimental Finance, Elsevier, vol. 20(C), pages 80-91.
    4. Ravi Dhar & Ning Zhu, 2006. "Up Close and Personal: Investor Sophistication and the Disposition Effect," Management Science, INFORMS, vol. 52(5), pages 726-740, May.
    5. Weber, Martin & Camerer, Colin F., 1998. "The disposition effect in securities trading: an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 167-184, January.
    6. repec:bla:jfinan:v:43:y:1988:i:3:p:677-97 is not listed on IDEAS
    7. Henrik Andersson, 2007. "Are commodity prices mean reverting?," Applied Financial Economics, Taylor & Francis Journals, vol. 17(10), pages 769-783.
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    Cited by:

    1. Bouteska, Ahmed & Kabir Hassan, M. & Gider, Zeynullah & Bataineh, Hassan, 2024. "The role of investor sentiment and market belief in forecasting V-shaped disposition effect: Evidence from a Bayesian learning process with DSSW model," The North American Journal of Economics and Finance, Elsevier, vol. 71(C).

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    More about this item

    Keywords

    disposition effect; prospect theory; commodities; behavioural finance; trading decision-making; REF fund;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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