The Disposition Effect and Under-Reaction to News

Posted: 28 Jul 2005


This paper tests whether the tendency of investors to sell stocks in their portfolios that have gone up, not down, in value since purchase, known as the disposition effect, induce under-reaction to news, leading to return predictability and a post-announcement price drift. The disposition effect implies that stock prices under-react to bad news when more current holders are facing a capital loss, and under-react to good news when more current holders are facing a capital gain. I use a database of mutual funds holdings to construct a measure of reference prices for individual stocks. Using this new measure of capital gains, I show that post-event predictability is most severe where the disposition effect predicts the biggest under-reaction. Post-event drift is larger when the news and the capital gains overhang have the same sign, and the magnitude of the drift is directly related to the amount of unrealized capital gains (losses) experienced by the stock holders, prior to the event date. An event-driven equity strategy based on this effect yields monthly alphas of over 200 basis points.

Keywords: Disposition Effect, Under-reaction, Earnings announcements, Behavioral Finance

JEL Classification: G10, G11, G14

Suggested Citation

Frazzini, Andrea, The Disposition Effect and Under-Reaction to News. Journal of Finance, Forthcoming, Available at SSRN:

Andrea Frazzini (Contact Author)

AQR Capital Management, LLC ( email )

Two Greenwich Plaza, 3rd Floor
Greenwich, CT 06830
United States
203-742-3894 (Phone)
203-742-3394 (Fax)


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