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
Date Written: December 13, 2019
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  and Pope and Schweitzer  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: Suggested Citation