Unraveling the Disposition Effect: The Role of Prospect Theory and Emotions

Abstract:     
This paper investigates experimentally the role of emotions in a robust behavioral anomaly, the disposition effect. We manipulate choice and responsibility for subsequent gains and losses, thus influencing the anticipated and experienced emotions at play. Merely experiencing a gain or loss, in the absence of responsibility, is not sufficient to produce a disposition effect, thus supporting recent theoretical claims that prospect theory alone can not explain the disposition effect. Introducing the emotions of rejoicing or regret, via choice and responsibility, is sufficient to produce a disposition effect. We conclude that emotions have an important role to play in economic decisions.

PLEASE NOTE: The final outcome of this line of work, with additional studies, is now in-press for OBHDP online.

Number of Pages in PDF File: 50

Keywords: disposition effect, emotion, regret, rejoicing, active/passive choice, experimental

JEL Classification: G10

working papers series