House Money, Counterfactual and the Disposition Effect

Abstract

We explore an issue of whether prior experience of sold stocks would affect the disposition effect, an inclination of selling winners than losers. We use the prior realized gain to serve as the proxy of house money and find that individual investors become more risk seeking (adverse) when they were harbored by a prior gain (loss) and therefore decrease (increase) the disposition effect. Moreover, we trace the ex-post return of the previously sold stock to capture the counterfactual learning effect. The counterfactual effect makes individual experiences regret (happiness) when the ex-post price trends up (down), and the sense of regret (happiness) will reduce (increase) the subsequent disposition effect. Using the Cox proportional hazard model to estimate the disposition effect we find that house money effect has a stronger impact than the counterfactual effect on the disposition effect. We further close up the analysis on individual characteristics and find house money and counterfactual effect differently on the disposition effect.