Download this Paper Open PDF in Browser

Can Prospect Theory Explain the Disposition Effect? A New Perspective on Reference Points

43 Pages Posted: 27 May 2011 Last revised: 5 Mar 2016

Juanjuan Meng

Peking University - Guanghua School of Management

Xi Weng

Peking University

Date Written: February 2016

Abstract

There is a recent debate on whether prospect theory can explain the disposition effect. Using both theory and simulation, this paper shows that prospect theory often predicts the disposition effect when lagged expected final wealth is the reference point, regardless of whether the reference point is updated or not. When initial wealth is the reference point, however, there is often no disposition effect. Reference point adjustment weakens the disposition effect, leads to more aggressive initial stock purchase strategies and predict history-dependence in stock holding. These findings also provide a explanation for why market experience reduces behavioral biases.

Keywords: disposition effect, prospect theory, loss aversion, reference point

JEL Classification: G02, D03

Suggested Citation

Meng, Juanjuan and Weng, Xi, Can Prospect Theory Explain the Disposition Effect? A New Perspective on Reference Points (February 2016). Available at SSRN: https://ssrn.com/abstract=1851883 or http://dx.doi.org/10.2139/ssrn.1851883

Juanjuan Meng (Contact Author)

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

HOME PAGE: http://www.gsm.pku.edu.cn/faculty_and_research/en/en_teacherDetail.html?crmurl=http://crm.gsm.pku.ed

Xi Weng

Peking University ( email )

Beijing, 100871
China

Paper statistics

Downloads
722
Rank
28,326
Abstract Views
2,043