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Title: Individual Characteristics and the Disposition Effect: The Opposing Effects of Confidence and Self-Regard
Authors: Kathryn Kadous, Professor of Accounting, Goizueta Business School; William B. Tayler (BYU); Jane Thayer (Georgia); and Donald Young, Ph.D. Student, Goizueta Business School
Journal: Journal of Behavioral Finance (forthcoming)
Sometimes, investors just can’t let go of a losing stock. Instead, they hold on too long, increasing their losses. The phenomenon is called the “disposition effect” and researchers have found that this effect occurs across trading regimes and cultures worldwide. While a variety of theories have been explored in hopes of understanding what drives the disposition effect, new research from two Goizueta Business School faculty, Kathryn Kadous, Professor of Accounting, along with two colleagues and a Goizueta Ph.D. candidate, Donald Young, suggests a simplified psychological explanation related to two distinct aspects of self-esteem. The researchers conducted an experiment to see how levels of self-regard (general self-esteem) and confidence in their investing ability (task-specific self-esteem) influence investors’ tendency to hang on to losing investments. In a forthcoming paper, they report that investors with lower self-regard as well as those with higher confidence were more likely to suffer from the disposition effect; those with higher self-regard and lower confidence, meanwhile, were more likely to dump losing stocks.
The researchers started their analysis by re-visiting a previously explored theory about the disposition effect — the idea that investors hang on to losing stocks because they believe their securities are bound to bounce back. They asked 112 MBA students to participate in an experiment that asked some to select from a choice of food processing companies and then make a hypothetical investment. Other study participants were asked to choose between companies to follow as prospective – but not current investors. After an initial period of time, active and prospective investors were asked whether they would invest $10,000 in the stock for a subsequent period of time. Current investors, it turns out, were more likely to do so. The study was designed so that some current and prospective investors saw their stock’s price decline during the initial observation period. After witnessing such a decline, current investors were much more likely to stick with a stock than prospective investors. The differences in behavior are key, the researchers wrote, because if the disposition effect can be explained by investors’ faith that stock prices are bound to bounce back, then it should apply equally to current and prospective investors.
In a second experiment, the researchers tested the notion that a psychological cause could be at play by having 86 students participate in a simulated stock trading exercise involving six securities. Before trading began, participants answered a series of questions to assess their levels of self-regard and confidence – two distinct aspects of self-esteem. Self-regard is a person’s overall evaluative view of oneself, researchers noted, adding that having a positive view of oneself helps people weather threats. Confidence, meanwhile, is a belief about one’s ability to bring about positive outcomes in a particular setting. For the trading exercise, participants sat at computer terminals that displayed price changes. They could buy and sell stocks as they saw fit, recognizing that their compensation for the study depended directly on their success in building total assets. Stock prices displayed on the terminals moved in ways that let participants use prior price information to predict future movements, implying that past price trends likely would not turn around. The optimal response to observing a trend of prior price declines, in other words, would be to sell immediately. Researchers found that study participants with low self-regard or high confidence were more likely to hold onto losing stocks. The results suggest that people with high self-regard can better recognize a stock’s poor performance and act accordingly, the researchers wrote. Also, highly confident investors apparently feel more threatened by recognizing a loss, and therefore hold a stock longer in hopes that it will recover, despite recovery being very unlikely.
The study shows the importance of separating self-esteem into its various components when conducting studies of motivation, the researchers concluded. The results also temper previous conclusions that suggested investor sophistication might explain the disposition effect, and therefore give rise to different or additional policy recommendations.
“While providing information and training for lower status investors is likely helpful in reducing the disposition effect for these individuals, providing them with an ego boost in an area unrelated to investing may be a more effective solution,” the researchers concluded. “More confident investors, on the other hand, may need very strong warnings about future investment performance or extrinsic reminders of their own past failure rate.”
– Chris Snowbeck