The disposition effect refers to investors' tendency to sell assets that have increased in value and hold on to assets that have lost value. This effect increases capital gains taxes paid by investors and reduces returns. It underlies patterns in market trading volume and stock price momentum. At an individual level, avoiding this effect reduces losses and taxes paid. At a systemic level, funds exhibiting a strong disposition effect underperform others and are less likely to survive long-term. The disposition effect is driven by prospect theory and loss aversion, as investors are reluctant to realize losses.

1. DISPOSITION EFFECT ON
FINANCIAL MARKETS
BY Group 7
NEELABH BARUA Sayyed Ali Maulin Kumar
Ram Soni Mansi Gupta Mahesh
Wadhwa

2. What is “Disposition Effect”
 It refers to investor’s tendency to sell assets that have increased in value while keeping
assets that have dropped in value
 Example:
Imagine that you need money to finance your upcoming summer travel plans. You
are looking at your investment portfolio to decide what financial moves to make.
You narrow it down to selling shares of two different companies. Let’s call them Company A and
Company B. Company A is up in value from where you purchased it. Company B is at a lower
standing than the price you bought in at. Their prices have both been relatively stable in the past
few weeks. Selling stock in either company would set you up in a solid spot financially for your
travels. So, which do you sell: Company A or Company B?

3. IMPORTANCE

4.  Understanding how letting go of losers and holding on to winners ultimately benefits
us long-term can incentivize us to unlearn our costly disposition
 Disposition effect increases the capital gain taxes that investors pay and reduces
returns even before taxes
 This effect underlies patterns in market trading volume
 It also plays a part in stock market underreactions, leading to price momentum.

5. EFFECTS

6. INDIVIDUAL EFFECTS
 Clever decision-making and good financial performance must be
grounded in a comprehensive point of view, rather than an outlook of
one-off wins and losses. A keen investor would cut their losing assets
over selling assets that will likely continue “winning”. By succumbing to
the disposition effect, we are incurring more losses and fewer gains in
the long-term.
 Taxation policies also increase the costs of the disposition effect. it is
more profitable to realize our losses in the short term because it will
result in a lower tax burden. All in all, avoiding “disposition investing” is a
win-win: fewer losses and fewer taxes.

7. SYSTEMIC EFFECTS
 Disposition effect can determine whether a firm would sinks or swim in the market. On the level of an
investment firm, selling winners early and losers late could incur major long term losses for the
group. Example In the Mutual Fund market, researchers examined the extent of the disposition effect
at over 2,300 active mutual funds, and the overall performances of these mutual funds. They found
that, on average, “disposition-prone” mutual funds fall behind non-disposition-prone funds by 4-6%
each year. They also found that disposition-prone funds are less likely to survive.
 Disposition effect also aligns with sunk cost fallacy. Example:
a. In 1990, the Denver airport wanted to install a new strategy for luggage handling. So, for the
investors funded for this project an amount of $2 billion. Despite all the warning signs, this
project continued to be funded for 2 years and ultimately failed
b. During the entire Vietnam war, America continued to invest for 20 years in the military. This
ultimately resulted in a huge loss for the American economy and it became on of the biggest
contributor of the 1965 Great inflation in the country.

8. Does Disposition Effect have an Impact on
Investment Decision
Creates more
demand
intensify trends in
stock prices
Affect trading
volumes
Emotion Driven
Effect

9. CAUSE

10. 1. What Is the Prospect Theory?
2. How the Prospect Theory
Works
3. Why Is Prospect Theory
Important?
4. What Are the Main
Components of Prospect Theory?
5. Example of Prospect Theory

11. Mental
accounting
Mental accounting a concept developed by Richard Thaler
refers to the different values people place on money based
on some subjective criteria that often leads to detrimental
results.
It leads to people making irrational investment decisions and
make them behave in financially detrimental ways.
To avoid mental accounting bias individuals should allocate
money as equal when they make use of it.

12. Loss Aversion And Disposition effect
Fear of loss
Hold stock
Disposition effect

13. Culpable Bias
 Small-Small multiple loss
gives more pain compared to
single loss of same amount
and Vice-versa.

14. Other Factors Except Money
 Investors Focus Upon
 Diversification
 Strategies
 Moral/Confidence
 Loss Cover
 Investors Neglect
• Time Value of Money
Loss Because of Disposition Effect

15. HOW TO MEASURE

16. UNREALIZED GAIN
A gain is realized when the asset is disposed of for profit.
“Unrealized Gain” refers to a rise in the value of an investment that an investor owns
but has not yet sold for cash, such as an open stock position.
Example

17. UNREALIZED LOSS
 Unrealized loss is the inverse of unrealized gain. It happens when the price of an asset
falls after an investor buys it but does not sell it.
 A realized loss is the opposite of a realized gain. It happens when an asset is sold for
less than the original purchase price.
 Example

18. HOW TO AVOID

19. Hedonic
Effect

20. THANK YOU