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Investors' Decision to Trade Stocks - An Experimental Study

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Abstract:

This paper experimentally examines the behavior of investors when buying and selling stocks. This behavior was tested under different conditions, among them restrictions on asset holdings or different information conditions. Basic financial theory suggests that subjects buy and sell according to expectations regarding the future prices of assets. On the other hand, behavioral biases, such as the disposition effect, suggest that subjects are affected by past performance of assets. In a series of experiments, subjects were asked to allocate a given endowment among six assets. All the assets had the same normal distribution with positive mean. The results show no disposition effect in the simple case with no restrictions. A reverse disposition effect was found in case 2, where subjects were required to hold only three assets and change one asset on each round. However, when subjects received information on the market return each period, they showed disposition effect when gain and losses are measured relatively to the market. We explain these results by the disappointment effect and momentum trading behavior. The main contribution of the current research is to demonstrate that the disposition effect or momentum behavior can be a product of trading conditions.

Keywords: Behavioral finance; Disposition effect; Experimental economics; Momentum; Trading

Document Type: Research Article

DOI: https://doi.org/10.1080/15427560902902150

Affiliations: 1: Department of Management and Economics, Open University, Israel 2: The School of Business Administration, The College of Management, Israel

Publication date: 2009-04-01

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