Hyun-Jung Lee, Jongwon Park, Jin-Yong Lee, and Robert S. Wyer Jr.
Executive Summary
The number of individual stockholders in the United States hasrisen from 42.4 million in 1983 to 91.1 million in 2005, and the percentage of U.S. households owning equities has grown from 15.9% in 1983 to 50.3% in 2005. This increase could be due in part to the advent of Web-based transaction capabilities (i.e., e-trading), which has dramatically increased the ease of making stock transactions.
This article examines a particular phenomenon—namely, investors’ tendency to sell “winners” (stocks whose value has increased since the time of purchase) more quickly than “losers” (stocks whose value has decreased)—in a newly emerging Internet-based stock trading (e-trading) situation. However, this phenomenon, known as the “disposition effect,” can be dysfunctional. That is, it can result in a less-than-optimal profit and a greater-than-necessary loss. Thus, an understanding of the conditions under which the effect is reduced or eliminated could have implications for individual investors, policy makers, and brokerage firms.
Although the disposition effect has been demonstrated frequently in conventional stock trading, its generalization to the e-trading environment is not clear. Furthermore, the mechanisms that underlie the effect are not well understood. Consequently, the conditions under which the disposition effect might be eliminated have not been identified. The current research accomplishes three things. First, it establishes the existence of the disposition effect in e-trading under conditions comparable to those that exist outside the laboratory. Second, it evaluates several possible determinants of the effect, the relative influence of which had not previously been articulated. Third, it identifies conditions under which the disposition effect can be eliminated.
Study 1 provides strong evidence of the disposition effect in an e-trading situation, based on an analysis of transaction data in a simulated e-trading environment. The average holding period of stocks was only approximately 3.95 days for winners and 6.21 days for losers. Moreover, the effect occurred regardless of both the price trend of the stock market as a whole and the level of stock trading experience of individual investors.
Three laboratory studies then examine the two alternative mechanisms that underlie the effect. First, the “value-function” hypothesis assumes that investors attach different subjective values to gains and losses when a stock is a winner than they do when a stock is a loser. Specifically, a loss is more aversive if the stock is a winner than if it is a loser, whereas a gain is more attractive if a stock is a loser than if it is a winner. Second, the “likelihood-focus” hypothesis assumes that investors have different beliefs about the future prospects of winning and losing stocks. That is, they believe that winners are more likely to decrease in price than losers.
Studies 2–4 provide evidence against the likelihood-focus hypothesis. That is, the experimental manipulation of the subjective likelihood of future gains or losses significantly changed participants’ future price perceptions but had little impact on the magnitude of the disposition effect. Conversely, the manipulation of the status of stocks as winners and losers significantly influenced the magnitude of the disposition effect but had no effect on predictions that the prices would change in the future.
Instead, this research provides evidence that the disposition effect is mediated by differences in the subjective value that people attach to potential gains and losses, depending on whether a stock is a winner or a loser. In Study 3, participants performed a task that required the assumption of a linear relationship between outcomes and the subjective values assigned to them. Performing this task, which changed the shape of the value function that typically governs this relationship, completely eliminated the disposition effect. Study 4 obtained evidence of a strong disposition effect when participants made selling decisions about their own stocks; they were more risk averse when the stock was a winner than when it was a loser. However, the effect was eliminated when participants made transactions on behalf of another person and were relatively indifferent as to whether the stock was a winner or loser. This was the case even though participants’ own predictions of the future prices of these stocks did not differ in the two conditions.
This research has potential implications for individual investors and for stock agents. The easy access to the stock market through the Internet has dramatically increased the number of individual stock investors. Nevertheless, such investors are vulnerable to the disposition effect, the consequences of which could be undesirable. To avoid these consequences, perhaps brokerage firms should advise their clients to focus less on their initial purchase prices and more on information that is relevant to stocks’ prognosis. Conversely, Study 4 suggests that individual investors may be unable to overcome the disposition effect even when they are strongly motivated to make accurate selling decisions. A better strategy for investors might simply be to entrust stock agents with their selling decisions or invest in mutual funds rather than in stocks.
Biography
Hyun-Jung Lee is Manager of the Sales & Marketing Institute atSamsung Electronics Co. She obtained a PhD from Korea University Business School. Her research interest is in financial decision making, customer relationship management, and channel strategy. She conducts a wide range of marketing consulting and teaches consumer behavior, marketing strategy, consumer relationship management, and marketing channels.
Jongwon Park is Professor of Marketing at Korea University’s Business School. He obtained a PhD from the University of Illinois at Urbana–Champaign and previously was on the marketing faculty at the University of British Columbia. His research interests are in the information processing underlying consumer judgments and choices, brand management, and behavioral decision theory. Dr. Park’s publications appear in leading journals, including Journal of Consumer Research, Journal of Consumer Psychology, Journal of Marketing Research, and Journal of Personality and Social Psychology.
Jin-Yong Lee is Professor of Marketing in the Department of Business Administration at the Seoul National University of Technology. He has obtained a PhD from the University of California, Berkeley. His research interest is in behavioral decision theory and brand management.
Robert S. Wyer Jr. is Professor Emeritus of Psychology at the University of Illinois and is currently Visiting Professor of Marketing at Hong Kong University of Science and Technology. Dr. Wyer’s research interests focus on various aspects of information processing, including the comprehension of information, its representation in memory, and its use in making judgments and decisions.
Journal of Marketing Research, Vol. XLV, No. 3, June 2008
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