The Disposition Effect in the Lab

We conduct controlled experiments in order to analyze individual trading behavior. Our results suggest that investors measure their gains relative to their initial wealth, and that this reference point together with past stock price changes determine the portfolio choices. Subjects choose a fixed-mix investment strategy in the loss zone and a contrarian strategy in the gain zone. The observed portfolio decisionsare in line with the house money effect. We reject the hypotheses that rebalancing, prospect theory with a fixed reference point, or the justification hypothesis explain the disposition effect.