Disposition Effect and Diminishing Sensitivity: An Analysis Based on a Simulated Experimental Stock Market

Abstract

The authors experimentally investigate the existence of the disposition effect and its relationship with diminishing sensitivity. Their approach includes 3 key characteristics: (i) an environment closely resembling actual stock markets, (ii) individual-specific reference prices, and (iii) a direct test of diminishing sensitivity as a correlate of the disposition effect. They find strong support for the existence of the disposition effect as an independent hypothesis. This is an improvement over previous studies, which tested this hypothesis only jointly with others. The authors' results also strongly point to diminishing sensitivity, of the type postulated by prospect theory, being positively associated with the disposition effect.

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