Persistent Profit and Portfolio Adjustment

Abstract

This study investigates investors’ behaviors on the ir portfolio adjustment after gain and loss. Using a unique data set of transaction data, the study supports the prospect theory that the investors will be more cautious after two consecuti ve gains. They reduce their portfolio’s systematic risk by giving less weight on large capi talization stocks. Investors fix their gain or loss relative to the purchasing price of the stocks . A number of literature show that investors’ risk pr eferences towards risk are not symmetric as being assumed in a traditional framework. Kaheneman and Tversky (1979) first proposed the prospect theory. The theory replaces utility function with value function that is concave on gain and convex on loss relative to the initial wealth to explain investors’ preference. The new function can explain both risk-taking and r isk-averse behaviors normally found in the market. Recent empirical studies that use experime ntal data and market data support the idea. Using a unique data set of Thai investors’ portfoli o, this study contributes in two areas. It is the first study that investigates gain or loss from two -consecutive trading. Secondly, it investigates the portfolio adjustment of investors after gain or loss. The study measures the adjustment in terms of systematic risk, diversification, and sent iment. The results confirm asymmetric impact on trading st rategy made by investors after gain or loss. The two-consecutive trading day framework allows us to confirm that the investors lower their portfolio’s risk after two consecutive profitable trading days. They seem to fix their reference points in judging gain or loss with the p urchasing price. Since one third of the portfolio is invested in large capitalization stock s, the result is in line with Kliger and Kudryavtsev (2008) who suggested that the reference point adaptation is mostly found in low capitalization stock with limited information. If the investors realize their gain in the first perio d and still have profitable trade in the second perio d, they will readjust weights of existing stocks in their portfolio to be more diversified rather th an buying a new stock. The impact is profound when their portfolio consists mainly of the large c apitalization stocks. The investors become