Abstract
The disposition effect refers to the investors’ tendency to disproportionately sell more winning than losing assets. This experiment evaluates its two competing behavioral mechanisms: belief in mean reversion and prospect theory. The participants were endowed with some hypothetical assets, observed their price sequences and made selling decisions. Sixty-one percent of them exhibited significant disposition effect. I elicited the participants’ prospect theory parameters and beliefs about price movements, and found that beliefs especially in the loss domain, not prospect theory, significantly contribute to the between-subject variation in the disposition effect. The results from a goodness-of-fit test also favor the belief mechanism.
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