How the Disposition Effect and Momentum Impact Investment Professionals

Abstract:     
More than twenty years ago, Meir Statman and I coined the term disposition effect to describe the predisposition of investors to sell their winners too early and to ride their losers too long. We identified a series of psychological phenomena that we believed explained the disposition effect, presented data consistent with the effect, and proposed some testable hypotheses. Since that time, a literature on the disposition effect has developed to test those hypotheses and extend the focus of discussion from investor behavior to pricing.

In this article, I survey highlights of the disposition effect literature that are of special interest to investment professionals. Recent research concludes that the disposition effect impacts investment professionals, both directly and indirectly. The direct effect involves investment professionals tending to sell their winners too quickly and/or riding their losers too long. The indirect effect involves momentum in pricing that in part stems from some investors behaving in accordance with the disposition effect. Notably, the disposition effect and momentum are key determinants in the separation of outperforming investors from underperforming investors.

Number of Pages in PDF File: 12

Keywords: Disposition Effect, Behavioral Finance, Momentum, Investment Consultants, Investment Professionals

JEL Classification: G11, G12, G14

Accepted Paper Series