Is the Disposition Effect Related to Chronic Individual Investor Differences in Emotion Regulation and Reliance on System 1 or System 2 Processes?

Abstract

We investigate the relationship between susceptibility to the disposition effect (DE) and chronic individual differences in reliance on System 1 or System 2 processes and habitual emotion regulation strategies. Using UK stock market investors’ trading records, we measure their susceptibility to the DE. An online questionnaire was used to assess these investors’ reliance on System 1 and System 2 processes and use of reappraisal and expressive suppression emotion regulation strategies. Investors with higher reliance on System 1 processes have greater DE but reliance on System 2 processes is not related to the DE. Use of reappraisal strategies to regulate emotions whilst investing reduces the DE, but use of expressive suppression does not show reduction of this bias. These results suggest that investors’ intuitive emotional reactions to gains and losses explain susceptibility to the DE, and that effective methods of regulating emotions enable this bias to be overcome.

Keywords: Disposition effect, dual-process theory, emotion regulation, financial decision-making bias, behavioral finance

JEL Classification: D81, D1, G11, G2