Review of Finance (2005) 9: 305–351
© Springer 2005
Do Investor Sophistication and Trading Experience
Eliminate Behavioral Biases in Financial Markets?
and MARK S. SEASHOLES
Bear Stearns and Co;
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
. 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.
This paper asks: do investor sophistication and trading experience attenuate (or
even eliminate) behavioral biases in ﬁnancial markets? We pay particular attention
to the reluctance of investors to realize losses and the propensity to realize gains
– a behavior known as the
. Our work is motivated by the large
amount of research concerning the disposition effect over the past two decades.
The disposition effect affects individual investors, home buyers, futures traders,
professional account managers, experimental laboratory subjects, proprietary stock
traders, and ﬁnancial institutions.
In a very comprehensive study of investment
behavior in Finland, Grinblatt and Keloharju (2001) show strong evidence of
We thank a national securities ﬁrm in China for providing the data used in this study. We are
especially grateful to Terry Hendershott who has been instrumental in the development of this paper.
In addition, we thank Brad Barber, Sanjiv Das, Kenneth Froot, Alok Kumar, John Nofsinger, Ter-
rance Odean, Jeremy Stein, Andrei Shleifer, and Nancy Wallace for their suggestions. We also thank
participants of seminars at Santa Clara University, UC Berkeley, UC Davis, and Wesleyan University.
Jack Chu was invaluable in preparing the data for analysis. An earlier version of this paper served
as Chapter One of Lei Feng’s doctoral dissertation titled “Do Demographics and Experience Change
the Disposition Effect?”.
Some of the best known empirical studies include: Shefrin and Statman (1985); Heisler (1994);
Odean (1998); Weber and Camerer (1998); Shapira and Venezia (2001); Grinblatt and Keloharju
(2001); Genesove and Mayer (2001); Coval and Shumway (2005); Garvey and Murphy (2004);
Locke and Mann (2005); and Locke and Onayev (2005). Appendix A, Panel I gives an overview