Prospect Theory and a Two-way Disposition Effect: Theory and Evidence from the Housing Market

62 Pages Posted: 23 Mar 2017 Last revised: 12 Dec 2019

See all articles by Zhaohui Li

Zhaohui Li

Old Dominion University

Michael Seiler

College of William and Mary - Finance

Hua Sun

Iowa State University

Date Written: December 13, 2019

Abstract

We model a home seller's pricing decision under a generally defined prospect value function. We show a simple disposition effect is caused by reference dependence, but it only exists when the agent is risk neutral. Diminishing sensitivity will lead to a two-way disposition effect by generating a local reverse disposition effect, a range in which the seller's asking price decreases with increasing potential loss. Loss aversion tends to magnify the disposition effect and hence mitigates the reverse disposition effect. One direct implication is that acclaimed tests on loss aversion such as Genesove and Mayer [2001] and Pope and Schweitzer [2011] are likely invalid. We present evidence consistent with the model by using multiple listing service data from Virginia. Our findings suggest that studies which predominantly focus on a one-way disposition effect can be overly simplistic and misleading as it depends on the strong assumption of risk neutrality.

Keywords: Loss Aversion, Prospect Theory, Housing Market, Disposition Effect, Price Dispersion Effect

JEL Classification: D03, R30

Suggested Citation

Li, Zhaohui and Seiler, Michael and Sun, Hua, Prospect Theory and a Two-way Disposition Effect: Theory and Evidence from the Housing Market (December 13, 2019). Available at SSRN: https://ssrn.com/abstract=2939186 or http://dx.doi.org/10.2139/ssrn.2939186

Zhaohui Li

Old Dominion University ( email )

Norfolk, VA 23529-0222
United States

Michael Seiler

College of William and Mary - Finance ( email )

VA
United States

HOME PAGE: http://mason.wm.edu/faculty/directory/seiler_m.php

Hua Sun (Contact Author)

Iowa State University ( email )

Ames, IA 50011-2063
United States
1-5152947514 (Phone)

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