Rational Disposition Effects: Theory and Evidence

August 2015 (with Daniel Dorn).

The disposition effect is a longstanding puzzle in financial economics. This paper demonstrates that it is not intrinsically at odds with rational behavior. In a rational expectations model with asymmetrically informed investors, trading strategies as predicted by the disposition effect can arise as an optimal response to dynamic changes in the information structure. The model predicts that the disposition behavior of less-informed investors weakens after events that reduce information asymmetries and are concentrated in stocks with weak return persistence. The data, trading records of 50,000 clients at a German discount brokerage firm from 1995 to 2000, are consistent with these predictions.

button paper2