The paper discusses the current state of the behavioral finance literature. I argue that more direct evidence on investors ’ actions and expectations would make existing theories more convincing to outsiders and would help sort among behavioral theories for a given asset pricing phenomenon. Furthermore, evidence on the dependence of a given bias on investor wealth/sophistication would be useful for determining if the bias could be due to (fixed) information or transactions costs or is likely to require a behavioral explanation, and for determining which biases are likely to be most important for asset prices. I analyze a novel data set on investor expectations and actions obtained from UBS PaineWebber/Gallup. The data suggest that, even for high wealth investors, expected returns were high at the peak of the market, many investors thought the market was overvalued but would not correct quickly, and investors ’ beliefs depend strongly on their own investment experience. I then review evidence on the dependence of a series of “irrational ” investor behaviors on investor wealth and conclude that many such behaviors diminish substantially with wealth. As an example of the cost needed to explain a particular type of “irrational”

This paper develops a test of under-reaction to news induced by the presence of investors who display the tendency to realize gains and ride losses, known as the disposition effect. The disposition effect, a widely documented fact in investor behavior, implies that stock prices underreact more to bad news when more current holders are facing a capital loss, and under-react more 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 novel measure of reference price, I show that post-event predictability is most severe when the disposition effect predicts the biggest under-reaction. I show that exposure to a disposition variable spreads the cross-sectional differences in post-event returns: post-event drift is bigger when the news and the capital gains overhang have the same sign and the magnitude of the post-event drift is directly related to the amount of unrealized capital gains (losses) experienced by the stock holders prior to the event date.

Abstract. This paper provides an in depth analysis of an investor’s reluctance to realize losses and his propensity to realize gains – a behavior known as the disposition effect. Together, sophistication (static differences across investors) and trading experience (evolving behavior of a single investor) eliminate the reluctance to realize losses. However, an asymmetry exists as sophistication and trading experience reduce the propensity to realize gains by 37 % (but fail to eliminate this part of the behavior.) Our research design allows us to follow an individual’s behavior from the start of his investing life/career. This ability makes it possible to track the evolution of the disposition effect as it is reduced and/or disappears. Our results are robust to alternative explanations including feedback trading, calendar effects, and frequency of observation. 1.

EFA conferences. Meir Statman acknowledges support from the Dean Witter Foundation. We

Economists have long been puzzled by the tendency of investors to sell winning investments too soon and hold losing investments too long. Several behavioral explanations for this phenomenon, known as the disposition effect, have been advanced. This paper demonstrates that disposition effects are not intrinsically at odds with rational behavior. Specifically, we show (i) that disposition effects arise quite naturally in a world with changing information asymmetry, (ii) that existing empirical tests rejecting an information-based explanation are inconclusive, and (iii) that disposition effects are consistent with price momentum. We further derive new empirical implications relating disposition behavior to trading volume, return variability, and price dynamics.

We study the trading of individual investors using transaction data and identifying buyeror seller-initiated trades. We document four results: (1) Small trade order imbalance correlates well with order imbalance based on trades from retail brokers. (2) Individual investors herd. (3) When measured annually, small trade order imbalance forecasts future returns; stocks heavily bought underperform stocks heavily sold by 4.4 percentage points the following year. (4) Over a weekly horizon small trade order imbalance reliably predicts returns, but in the opposite direction; stocks heavily bought one week earn strong returns the subsequent week, while stocks heavily sold earn poor returns.

Vuolteenaho, and seminar participants at the American Finance Association 2004 Meetings, Harvard University,

Abstract not found

∗We are grateful to the Center for China in the World Economy (CCWE) of the School

We analyze trading records for 66,465 households at a large discount broker and 665,533 investors at a large retail broker to document that the trading of individuals is highly correlated and persistent. This systematic trading of individual investors is not primarily driven by passive reactions to institutional herding, by systematic changes in risk-aversion, or by taxes. Psychological biases likely contribute to the correlated trading of individuals. These biases lead investors to systematically buy stocks with strong recent performance, to refrain from selling stocks held for a loss, and to be net buyers of stocks with unusually high trading volume.