Disposition effects and underlying mechanism in e-trading of stocks

Abstract

People have a tendency to sell stocks more quickly if their value has increased since the time they were purchased than if their value has decreased during this period. This "disposition effect" can sometimes have negative financial consequences. Based on an analysis of transaction data in a simulated trading environment, Study 1 provides evidence of the disposition effect in a newly emerging Internet-based stock trading ("e-trading") situation. Three laboratory studies then examine the mechanisms that underlie the effect. The magnitude of the disposition effect is unaffected by experimental manipulations of the subjective likelihood of future gains or losses. However, it is eliminated by inducing participants to define gains and losses in similar subjective units. Furthermore, the effect depends on whether participants make selling decisions on their own stocks or serve as an agent for someone else. Thus, the disposition effect is largely a result of differences in the subjective value that participants attach to possible gains and losses rather than of differences in their beliefs that these outcomes will occur. The authors discuss theoretical and managerial implications of the findings.