Prospect theory and disposition patterns: evidence from Taiwan investors

Purpose - The purpose of this paper is to demonstrate that various disposition patterns in terms of the price changes are plausible under the Prospect Theory (PT), which argues that investors have a greater tendency to sell assets that have risen in value since the purchase than those that have fallen. Numerous empirical evidences have shown that investors demonstrate the disposition effect (DE). This study highlights that, when the disposition measure is defined by the stock price changes, the PT predicts the DE indeed. It also indicates other seemingly contradicting disposition patterns: the reversed disposition effect and the pattern of the symmetry over gains and losses. Design/methodology/approach - To show that the disposition effect is only one of the disposition patterns under the preference of PT, as part of this study the authors apply the mental account theory and propose two decision criteria for the gain and loss accounts, respectively, (i.e. maximum loss tolerated and minimum gain required). An empirical analysis was performed from a large-scale market survey in Taiwan to examine individual investors' disposition patterns. Findings - The findings show that more than 50 percent of individual investors demonstrate their disposition patterns other than the disposition effect. Many investors show the reversed disposition effect or the pattern of symmetry (holding about the same magnitude of gains or losses before realization). Originality/value - This study answers the questions which, to the authors' knowledge, have not been incorporated in the studies of the PT or the DE: first, when do investors sell losers which they are inclined to hold on to? Second, for how long do they hold winners which they are eager to sell? The authors' arguments allow various disposition patterns to exist simultaneously, without changing the value function in the PT of convexity over losses and concavity over gains and without requiring strict assumptions on the expected stock returns.