A Study of Disposition Effect among China's Individual Investors: the Perspective of Irrational Beliefs
WU Jiawei, WANG Changyun, CHEN Zilin, Jie Michael Guo
Futures and Derivatives Research Department, China Institute of Finance and Capital Markets; China Financial Policy Research Center, Renmin University of China; Macro Research and Asset Management Department, China Southern Asset Management Co. Ltd.; Durham University Business School
Summary:
The disposition effect refers to a robust trading phenomenon in which both individual and institutional investors are more likely to sell an asset when it is at a gain than when it is at a loss. The disposition effect is common in the stock market, the futures market, the real estate market, and other financial markets. However, as widespread as the disposition effect is, the literature has not reached consensus on its mechanism. We extend the literature by showing the significant impact of investor sentiment on the disposition effect both theoretically and empirically. The theory of investor preference and the theory of rational belief are the two main explanations for the disposition effect. Kahneman and Tversky's (1979) prospect theory attributes the disposition effect to the features of investors' preferences, as described by the S-shaped value function. Investors are more risk averse when facing profits and more risk seeking when facing a loss. Therefore, investors prefer to sell profitable stocks to realize gains and hold loss stocks to wait for recovery. One basic assumption of present prospect theory models and relevant modified models is that investors' expectations regarding the probability of stock price change are equal to the real probability (Barberis and Huang, 2008; Barberis and Xiong, 2009). As this assumption fails to describe the fact that investors usually have irrational expectations, the present prospect theory model does not include the documented impact of investor sentiment on trading behavior and asset pricing (Antoniou et al., 2013; Da et al., 2015). To fill this gap, we introduce investor sentiment into the prospect theory model and study the potential impact of investor sentiment on the disposition effect. Irrational investors usually fail to properly estimate the price expectation of a risky financial asset (normally a stock). Therefore, we describe investor sentiment by using investor expectation bias on the probability of stock price change for different cases (Barberis et al., 1998) and modify the prospect theory model based on the binomial tree model in Barberis and Xiong (2009). We define investors' irrational expectations regarding the probability of stock price increase as πs and the actual probability of stock price increase as πo. The difference (Δ) between πs and πo represents the extent to which an investor overestimates the probability of stock price increase (Dumas et al., 2009; Shefrin and Statman, 1994). When market sentiment is high, investors are often more overconfident and more optimistic, such that Δ>0. We construct a discrete-time portfolio decision-making model derived from investors' irrational expectations and obtain a series of simulation results for investors' optimal portfolio choices under limited capital based on the parameters in Barberis and Xiong (2009) and the PGR/PLR measures of the disposition effect used in Odean (1998). The results indicate that investors' disposition effect decreases as Δ increases, showing the essential role of investor sentiment in the disposition effect. We base this study on a transaction-level dataset of approximately 1.77 million individual investors from a large anonymous national Chinese broker from 2007 to 2009. We also include investors' daily positions so that we can match and calculate the PGR and PLR indexes. The sample covers a striking bull and bear period for China's stock market, which offers a natural environment in which to study the impact of investor sentiment on the disposition effect. Consistent with previous studies, our results show strong evidence of the disposition effect in China's stock market. On average, the likelihood of a sale for Chinese stock investors is 20% higher when a gain is realized than when a loss is realized. We regress the monthly measure of the disposition effect on monthly market investor sentiment after controlling the market momentum variable. The results verify our hypothesis that investors' disposition effect decreases when market sentiment is higher. Specifically, the disposition effect is 0.1% lower when market sentiment increases by 1%. Additionally, the disposition effect is even weaker in stocks that are more difficult to evaluate (e.g., stocks with a low book-to-market ratio and lower capitalization) due to the mechanism of investor sentiment. Our results are robust when controlling the potential endogeneity using the dummy variable of the 2008 financial crisis as the instrumental variable. We contribute to the literature by studying the impact of investor sentiment on the disposition effect both theoretically and empirically. Affected by sentiment, investors hold biased expectations about future stock prices, thus changing their selling decisions toward profits and losses. Our results also shed light on the optimization of investors' decision-making processes.
作者简介: 武佳薇,经济学博士,助理研究员,中证金融研究院期货与衍生品研究部,E-mail:wjw7251@163.com.陈紫琳,经济学博士,分析师,南方基金管理股份有限公司宏观研究与资产配置部,E-mail:chenzilin@southernfund.com.Jie Michael Guo, 金融学博士,教授,杜伦大学商学院, E-mail:jie.guo@dur.ac.uk.
引用本文:
武佳薇, 汪昌云, 陈紫琳, Jie Michael Guo. 中国个人投资者处置效应研究——一个非理性信念的视角[J]. 金融研究, 2020, 476(2): 147-166.
WU Jiawei, WANG Changyun, CHEN Zilin, Jie Michael Guo. A Study of Disposition Effect among China's Individual Investors: the Perspective of Irrational Beliefs. Journal of Financial Research, 2020, 476(2): 147-166.
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