and Shefrin] Aversion to losses typically leads people to take chances
that they would not in other circumstances. Suppose that you have
a choice. You can accept a sure $500 or you can face 50-50 odds
that you will either win $1,000 or nothing at all. What would you
do if you actually faced this situation? Or suppose that you are
in the unfortunate situation where you have lost $500. However,
instead of accepting this loss, you can face 50-50 odds that you
either lose $1,000 or you lose nothing? What would you do if you
actually faced this situation? When asked the two questions above,
more than half of our students say they would take the sure $500
instead of taking a chance on winning $1,000. However, more than
half of students would take the chance of losing $1,000 instead
of accepting a sure loss of $500. Psychologists emphasize that although
people generally behave conservatively when it comes to risk, they
are much more willing to take risks when they think they might be
able to avert a loss. That, in turn, leads to the disposition effect.
"Most of us are not as willing to take financial risks as we
think. Most people like to think of themselves as risk takers, but
what they really want is a guaranteed outcome with some momentary
suspense to make them feel as if the outcome had been in doubt.
The momentary suspense adds the thrill factor necessary to keep
our lives from getting too boring".
"Often, in their portfolio, people, and among them the less
experienced, prefer to sell winners than losers (disposition effect).
They don't like to sell a stock on which there are losing money.
They prefer to keep it, taking the risk that its price will fall
even more. Their loss aversion is stronger than their risk aversion
or than their urge to seize gain opportunities. Another reason is
their reluctance to admit their mistakes or to fail to keep a commitment".
"Risk alone has no necessary relationship with investment return.
For instance, you don't get a higher expected return for holding
a poorly diversified portfolio, regardless of how risky it is (yes,
the range of returns will be wider, but the average return is not
correspondingly higher). So when we talk about there being a positive
relationship between expected return and risk, we're already assuming
that the selection, diversification, and optimization has been done
- that is, we already have a portfolio that provides the highest
expected return for a given level of risk".
Effect of Myopia and Loss Aversion on Risk Taking: An Experimental
Test, Thaler, Schwartz, Kahneman and Tversky, 1997
"Myopic loss aversion is the combination of a greater sensitivity
to losses than to gains and a tendency to evaluate outcomes frequently.
Two implications of myopic loss aversion are tested experimentally.
1. Investors who display myopic loss aversion will be more willing
to accept risks if they evaluate their investments less often. 2.
If all payoffs are increased enough to eliminate losses, investors
will accept more risk. In a task in which investors learn from experience,
both predictions are supported. The investors who got the most frequent
feedback (and thus the most information) took the least risk and
earned the least money".
Loss Aversion and the Equity Premium Puzzle, Ben-artzi and Thaler,
"The equity premium puzzle, first documented by Mehra and Prescott,
refers to the empirical fact that stocks have greatly outperformed
bonds over the last century. As Mehra and Prescott point out, it
appears difficult to explain the magnitude of the equity premium
within the usual economics paradigm because the level of risk aversion
necessary to justify such a large premium is implausibly large.
We offer a new explanation based on Kahneman and Tversky's 'prospect
theory'. The explanation has two components. First, investors are
assumed to be 'loss averse' meaning they are distinctly more sensitive
to losses than to gains. Second, investors are assumed to evaluate
their portfolios frequently, even if they have long-term investment
goals such as saving for retirement or managing a pension plan.
We dub this combination 'myopic loss aversion'. Using simulations
we find that the size of the equity premium is consistent with the
previously estimated parameters of prospect theory if investors
evaluate their portfolios annually. That is, investors appear to
choose portfolios as if they were operating with a time horizon
of about one year. The same approach is then used to study the size
effect. Preliminary results suggest that myopic loss aversion may
also have some explanatory power for this anomaly".
Professional Traders Exhibit Myopic Loss Aversion? An Experimental
Analysis, Haigh and List, 2005
Myopic loss aversion (MLA) tendencies may be attenuated among professionals.
Using traders recruited from the CBOT, we do indeed find behavioral
differences between professionals and students, but rather than
discovering that the anomaly is muted, we find that traders
exhibit behavior consistent with MLA to a greater extent than students.
Professional Traders Exhibit Loss Realization Aversion, Locke
and Mann, 2000
"In this paper we examine trades by populations of professional
futures traders for evidence of activity best described by the "behavioral
finance" literature. The data provide support for the existence
of a disposition effect (derived from the prospect theory of Kahneman
and Tversky 1979) among professional traders. We find that traders
hold losing trades longer than winning trades and that average position
sizes for losing trades are larger than for winners. Our evidence
also indicates that relative aversion to loss realization is related
to contemporaneous and future trader relative success".
Makes Investors Trade?, Grinblatt and Keloharju, 2001
"We find evidence that investors are reluctant to realize losses,
that they engage in tax-loss selling activity, and that past returns
and historical price patterns, such as being at a monthly high or
low, affect trading".
Behavioral Biases Affect Prices?, Coval and Shumway, 2001
"This paper documents strong evidence of behavioral biases
among Chicago Board of Trade proprietary traders and investigates
the effect these biases have on prices. Our traders appear highly
Asymmetry, Price Momentum, and the Disposition Effect, STROBL,
"Specifically, we show (i) that disposition effects arise quite
naturally in a world with changing information asymmetry, (ii) that
existing empirical tests rejecting an information-based explanation
are inconclusive, and (iii) that disposition effects are consistent
with price momentum".