Disposition Effect and Firm Size: New Evidence on Individual Investor Trading Activity

Abstract

Economists and investment professionals have long been puzzled by the tendency of individual investors to sell the winners from their stock portfolio and to hold on to the losers. I analyze the daily trading records of 78,000 clients of a discount brokerage house over six years and document, surprisingly, that such behavior (known as the disposition effect) is concentrated primarily in large-cap stocks. Trades in stocks at the bottom 40 percent of the market capitalization distribution exhibit a reverse disposition effect: investors keep their winners and realize their losers. Moreover, the relationship between firm size and the disposition effect appears to be monotonic. The larger the market capitalization of the firm, the more likely people are to realize their gain and to hold on to their loss. This new evidence challenges the current view of the literature that the disposition effect is an implication of a prospect-theory type of individual preferences.

I examine different potential explanations for the size dependence of the disposition effect, such as margin calls being triggered more often by the more volatile small stocks, different trading styles in small stocks and large stocks and different behavior with regard to small and large gains and losses. My findings are consistent with a view that individual beliefs rather than preferences are generating the disposition effect.

Keywords: disposition effect, risk taking, trading behavior

JEL Classification: D8, G00, G12