Do Investor Sophistication and Trading Experience Eliminate Behavioral Biases in Financial Markets?

TLDR

The study examines how investors’ disposition effect—reluctance to realize losses and tendency to realize gains—affects trading behavior. The authors longitudinally track individual investors from the beginning of their careers to observe how the disposition effect changes over time. Investor sophistication and trading experience eradicate loss‑realization reluctance but only partially curb gain‑realization propensity, reducing it by 37%, and these effects hold after controlling for feedback trading, calendar effects, and observation frequency.

Abstract

This paper provides an in depth analysis of an investor's reluctance to realize losses and his propensity to realize gains - a behavior known as the disposition effect. Together, sophistication (static differences across investors) and trading experience (evolving behavior of a single investor) eliminate the reluctance to realize losses. However, an asymmetry exists as sophistication and trading experience reduce the propensity to realize gains by 37% (but fail to eliminate this part of the behavior.) Our research design allows us to follow an individual's behavior from the start of his investing life/career. This ability makes it possible to track the evolution of the disposition effect as it is reduced and/or disappears. Our results are robust to alternative explanations including feedback trading, calendar effects, and frequency of observation.