Extreme market movements, the disposition effect, and subsequent return spreads: evidence from China

Abstract

ABSTRACT This study examines whether and how the interaction between extreme market movements and the disposition effect can affect subsequent return spreads between stocks with large paper losses and those with large paper gains for a sustained period of time. We study all the A-shares listed on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. Based on the prospect theory, our results show that after extreme negative market movements, the disposition effect enhances significant subsequent return spreads; however, it generates insignificant subsequent return spreads when extreme market movements are positive.