The Disposition Effect — Evidence about the Investors Aversion to Realize Losses: A Contribution to Behavioral Finance through the Use of Experimental Call Markets

Abstract

The paper analyses the results of a series of 13 experimental asset markets with 161 participants altogether regarding aspects of Behavioral Finance. Especially the disposition effect, the tendency of investors to hold investments that have lost value (''losers'') too long and sell investments that have gained value (''winners'') too early, is investigated. The disposition effect is one implication of extending the prospect theory to investing in financial assets. Of central importance is the reference point from which gains and losses are valued. Due to the fact that different people may use different reference points we tested for several reference points. The results for all used reference points demonstrate a strong preference of the participants for realizing winners rather than losers, meaning there is a great evidence on the existence of the disposition effect. The analyses of this paper have three main advantages. First, in contrast to most empirical analyses of the financial markets, which are realized on a high aggregation level, we can use individual's data due to our experimental approach. For that reason we are able to deliver more detailed and conclusive results. Second, in comparison to other experimental asset markets the used design of a call market with an open orderbook is more realistic, because the assets are not liquidated after each trading period. Third, we determine the asset prices endogenously in a manner similar to the price fixing in realstock markets.