feng_seasholes_RoF_2005 (1)

feng_seasholes_RoF_2005 (1) - Review of Finance(2005 9...

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Review of Finance (2005) 9: 305–351 © Springer 2005 Do Investor Sophistication and Trading Experience Eliminate Behavioral Biases in Financial Markets? ± LEI FENG 1 and MARK S. SEASHOLES 2 1 Bear Stearns and Co; 2 U.C. Berkeley 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. Introduction 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 disposition effect . 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. 1 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?”. 1 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
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306 LEI FENG AND MARK S. SEASHOLES the disposition effect for five investor types: non-financial corporations; financial
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feng_seasholes_RoF_2005 (1) - Review of Finance(2005 9...

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