Disposition effect and investor underreaction to information

Abstract

The purpose of this paper is to explain the underreaction of investors to information. In order to study the adjustment of prices to a fundamental value, we implement experimental markets with fluctuating fundamental values. The experimental design employed involves two treatments differentiated according to the information disclosed to the participants. The results show an underreaction to a change in the fundamental value. This underreaction is greatest when most of the subjects are facing a paper loss. This suggests that the disposition effect has a strong impact on price formation. Once most of the subjects are in a paper gain situation, the underreaction is at its lowest level when they receive good news. Thus, underreaction to information is influenced by paper gains and losses.