The Disposition Effect and Underreaction to Private Information

47 Pages Posted: 6 Mar 2020

See all articles by Dirk-Jan Janssen

Dirk-Jan Janssen

Radboud University Nijmegen - Department of Economics

Jiangyan Li

Dongbei University of Finance and Economics

Jianying Qiu

Radboud University Nijmegen - Nijmegen School of Management

Utz Weitzel

VU University Amsterdam; Tinbergen Institute; Radboud University

Date Written: February 6, 2020

Abstract

We examine the role of the disposition effect in market efficiency following the arrival of private signals to a small group of informed traders. Subjects trade an ambiguous asset via a computer-based double auction. Using a 2x2x2 design, we endow two types of signal, i.e., positive vs. negative, to informed traders with two different levels of the disposition effect, i.e., high vs. low, that are measured in two domains, i.e., gain vs. loss. We find that:

(1) the disposition effect measured in the gain domain has qualitatively different implications from the disposition effect measured in the loss domain;

(2) following a favorable signal, informed traders with high disposition effect levels are more likely to sell and less likely to hold the asset while following an unfavorable signal, the opposite is true;

(3) there is some evidence of stronger price under-reaction in markets with informed traders with high disposition effect levels than in markets with informed traders with low disposition effect levels, but the effect is overall relatively weak; and finally and most importantly

(4) the above results hold only when the sign of the signal matches the domain that the disposition effect levels of the informed traders are measured in.

Suggested Citation

Janssen, Dirk-Jan and Li, Jiangyan and Qiu, Jianying and Weitzel, Utz, The Disposition Effect and Underreaction to Private Information (February 6, 2020). Journal of Economic Dynamics and Control, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3533157

Dirk-Jan Janssen

Radboud University Nijmegen - Department of Economics ( email )

Nijmegen, 6500 HK
Netherlands

Jiangyan Li (Contact Author)

Dongbei University of Finance and Economics ( email )

China

Jianying Qiu

Radboud University Nijmegen - Nijmegen School of Management ( email )

Thomas van Aquinostraat 3
P.O. Box 9108
Nijmegen, 6500HK
Netherlands

Utz Weitzel

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Radboud University ( email )

Heyendaalseweg 141
Nijmegen, 6525 AJ
Netherlands

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