Koustav De is Assistant Professor in Finance at the Gatton College of Business & Economics, University of Kentucky.
Area of Interest:
Behavioral Finance (investor behavior)
Gatton College of Business & Economics,
University of Kentucky.
Using trading data from Finland and the US, I empirically show that investors tend to buy riskier stocks following realized losses. The measure of risk that the investors seem to pay attention to is the market beta of a stock. This behavior of buying higher beta stocks after a realized loss is observed in institutional as well as individual investors, but is more pronounced among individual investors with lower expertise, who on an average buy a new stock with up to 15% higher beta than that of the old stock they were holding. For an agent with utility consistent with prospect theory, this behavior emerges as the optimal response to her problem of maximizing utility within a mental account. Furthermore, this behavior can aggregate up during market downturns and cause return predictability in high beta stocks. With this insight, I suggest a modification to the betting against beta trading strategy that can improve the Sharpe ratio more than twofold.
Estimating the Reference Points of Investors with the Disposition Effect [download]
We estimate the reference points of individual investors that exhibit the disposition effect using proportional hazard models to fit their stock selling decisions. We find that while the likelihood function jumps significantly around a reference point of zero, the average maximum likelihood reference point is a positive number, generally around 60 to 190 basis points. Further, in most cases there is a higher secondary reference point around 300 basis points. This appears to stem from heterogeneity of reference point across individuals. We identify some characteristics that explain variation in reference point across individuals. We also find that quarterly primary reference points are correlated with past bond yield changes, past stock market return and individual experience of previous realized profits.