Up Close and Personal: An Individual Level Analysis of the Disposition Effect

Abstract:     
In this paper, we analyze the trading records of a major discount brokerage house to investigate the disposition effect, the tendency to sell winners too quickly than losers. In contrast to previous research that has demonstrated the disposition effect by aggregating across investors (Odean, 1998), our main objective is to identify individual differences in the disposition bias and explain this in terms of underlying investor characteristics. Building on the findings in experimental economics and self-correction in psychology, we hypothesize that investors' sophistication about financial markets and trading experience is responsible in part for the variation in individual disposition effect. Using demographic and socio-economic data as proxies for investors' sophistication, we find empirical evidence that wealthier and individual investors in professional occupations exhibit less disposition effect. Consistent with experimental economics, trading experience also tends to reduce the disposition effect. We provide guidelines for investment advisors, regulators and investment communities to utilize our findings and help investors make better decisions.

Keywords: Disposition Effect, Investor Sophistication, Individual Decision Making

JEL Classifications: G10

Working Paper Series