Revisiting disposition effect and momentum: a quantile regression perspective

Abstract

Behavioral finance theory stipulates that the disposition effect plays an important role in inducing momentum. Using quantile regression analysis, this research is twofold. First is to examine the relation between the unrealized capital gains and expected returns. Second is to examine the capability of disposition effect as one of the underreaction models in inducing momentum in the most extreme quantiles (0.05th and 0.95th) of expected returns. To do so, we use a sample of 5176 firms, from January 1998 to June 2015. Following Grinblatt and Han (J Financ Econ 78:311–339, 2005), the findings show that the relation between unrealized capital gains and expected returns is significantly positive and decline as the quantiles of expected returns increase from the lowest to the median expected return quantiles. However, they become significantly negative and rise with the increase of expected returns quantiles above the median expected returns quantile. This indicates that disposition-prone investors exhibit disposition behavior below the median and median expected return quantiles, but they display the opposite behavior above the median quantiles of expected returns. Our findings also suggest that the disposition effect is not a good noisy proxy for inducing momentum at the lowest quantile of expected returns (0.05th). However, the disposition effect induces contrarian behavior at the highest quantile of expected returns (0.95th).