Essays on Investor Behavior and Psychological Reference Prices

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School of Business | Doctoral thesis (article-based) | Defence date: 2003-05-09
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130 s.
Acta Universitatis oeconomicae Helsingiensis. A, 213
Psychological factors have a major impact on investor behavior, as shown by numerous academic studies in recent years. The essays included in this thesis contribute to existing literature on investor behavior, and its associated market consequences, with respect to certain stock price levels that have personal meaning to investors. Such psychologically important reference prices include the stock’s original purchase price, as well as previously obtained record high and low market prices. The first essay focuses on the determinants of the disposition effect, i.e. the tendency to hold on to losing investments and to sell winners. The main findings on a large panel of individual investors’ trades are the following: Risk aversion over gains and risk seeking over losses, as described by prospect theory, the leading explanation of the disposition effect in extant literature, does not fully account for the disposition effect. Secondly, holding on to losing shares is not motivated by a belief in mean-reverting returns, nor is it produced by investors acting on target prices, based on their subjective assessment of the stock’s fair value. The results are consistent with investors trying to break even and avoid realizing losses due to a need to justify past investment choices. The second essay investigates the immediate effect on trading volume, when the position of a large number of investors switches from losses to gains. This unique condition can occur in Initial Public Offerings (IPO), where many investors share the same purchase price. The results show a significant increase in turnover for negative initial return IPOs at the time they surpass the offer price for the first time. Attaining new high and low stock prices is also found to increase turnover significantly. The effect is stronger than the one produced by exceeding the purchase price. The third essay utilizes a similar setting in assessing the impact on market prices over the very short-term, as well as the medium-term horizons of several weeks. The results show no price impact on the days following the crossing of the offer price, which suggests that the disposition effect has no immediate aggregate impact due to demand and supply imbalance. Results of 4- to 12-week returns show a fairly strong tendency for trend continuation. That is, after crossing the offer price from below (above) the stock tends to continue to go up (down). Attaining a new high or low stock price is a significant predictor of trend continuation over the next two days.
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Puttonen, Vesa, professor
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