9/11/12
S tudy ’s F indings C hallenge Loss-A v ersion Theory | The G uru Inv estor
The Guru Investor
Thoughts, ideas and insight from the top minds in
the investment world
Free Guru Newsletter
Validea.com
The Guru Investor Book
Money Management
About
Posts
Study’s Findings Challenge LossAversion Theory
August 31, 2012 by The Guru Investor
0 Comments
One tenet of behavioral finance is the “disposition effect” — the tendency for investors to sell
winners rather than losers in their portfolio. And a common reason cited for why that occurs is
aversion to loss; locking in losses causes pain, while locking in winners causes positive feelings.
But a new study offers evidence that loss aversion isn’t at the heart of the disposition effect. In
“Are Investors Really Reluctant to Realize Their Losses? Trading Responses to Past Returns and
the Disposition Effect”, authors Itzhak Ben-David and David Hirshleifer find that investors’
beliefs — not preferences, like the preference not to experience pain — are the driving force
behind buy and sell decisions. ”People have a variety of reasons for trading stocks, which may
include tax issues, margin calls, and an aversion to losses,” Ben-David tells Scienceblog.com.
“These all may play a role, but what we show [is] that beliefs are dominant for the trading of
retail investors.”
Ben-David and Hirshleifer used stock transaction data from 1990 through 1996 from more than
77,000 accounts at a large discount broker, and examined when investors bought and sold
stocks, and how much they made or lost on the trades. For example, they looked at when
investors were more likely to buy more shares of a stock they’d already purchased. It turned out
it was more likely they bought more when the stock had gone down. ”If you buy additional
shares of a stock that has lost value, that suggests you are acting on your beliefs that the stock is
really a winner and other people have just not realized it yet,” Ben-David said. “You wouldn’t buy
additional shares of a losing stock if your biggest motivation was to avoid realizing losses.”
Ben-David said acting on beliefs rather than preferences (such as aversion to loss) doesn’t mean
investors are making rational decisions — they may be acting because of overconfidence or
other factors. He also says that the difference between acting on beliefs and acting on
preferences is a key one. “In economics, these two stories are very different,” he says. “Beliefs
and preferences are very different concepts, and it is important to distinguish them and how
they affect investors. Many economists had thought that an irrational aversion to selling losers
was crucial for the trading decisions of retail investors.”
Share this:
theguruinv estor.com/2012/08/31/study s-findings-challenge-loss-av ersion-theory /