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Empirical research of disposition effects in Vietnam’s stock market

Empirical research of disposition effects in Vietnam’s stock market. This paper examines some cognitive biases of Vietnamese stock investors by ana-lyzing trading records for 1,201 accounts at a brokeragef irm. These investors tend to make poor trading decisions by selling good stocks and buy ing bad stocks.

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Journal of Economics and Development Vol. 14, No.2, August 2012, pp. 52 - 71

ISSN 1859 0020

Empirical Research of Disposition Effects
in Vietnam’s Stock Market
Nguyen Duc Hien
National Economics University, Vietnam
Email: hiennd@neu.edu.vn

Ngo Duy
National Economics University, Vietnam

Le Vu
Australia’s National University, Australia
Nguyen Ngoc Tram
University of Bristol, UK


This paper examines some cognitive biases of Vietnamese stock investors by analyzing trading records for 1,201 accounts at a brokerage firm. These investors tend
to make poor trading decisions by selling good stocks and buying bad stocks. They
demonstrate a significant reference to holding the losing stocks and selling the wining stocks which is known as the disposition effect. It provokes many implications
for researchers, market practitioners and policy makers.
Keywords: Disposition effect, extrapolation bias, prospect theory, behavioral

Journal of Economics and Development


Vol. 14, No.2, August 2012

1. Introduction

hurts the wealth of investor. It could not exist
if market participants behaved in compliance
with the efficient market hypothesis and the
rationality assumption.

Among the three psychological foundations
of behavioral finance, emotional foundation
plays an important role in explaining individual behavior. Emotion is sometimes argued to
have a strong relationship with prospect theory (Kahneman and Tversky’s). “Fear” and
“greed” are two major emotions of individuals
found in financial markets. Recall the fact that
many people buy lottery tickets, which is contradictory to loss aversion in terms of gains.
Those people, at the same time, may buy
insurance, which is contradictory to riskseeking in terms of loss. Buying the lottery is
an exhibition of “greed”, expecting to get rich
quickly while buying insurance shows “fear”.
So, this example suggests that the nonlinearity of weighting function arises from emotion.
In emotion-rich situations, people’s weighting
function is expected to be more inverse-S
shaped. That emotion influences how individual investors make financial decisions,
researchers have found two behaviors. The
first is the house money effect, the inclination
to take on more risk after investment success.
The second is the disposition effect, which is
the behavior that we will examine in regard to
the Vietnamese stock market.

The Vietnamese stock market is a new and
emerging market in Asia. It started in July
2000, and now comprises three stock
exchanges: HOSE, HNX, and Upcom. The
dominant feature of the Vietnamese stock
market is the fact that investors are inclined
toward herd mentality, making the market
risky and low-liquidity. Other exhibitions of
investor cognitive psychology such as the disposition effect, extrapolation bias… have not
been examined yet. Therefore, our study aims
to disprove the efficient market in Vietnam
under the view of behavioral finance by testing the inclination of investors toward several types of behavior biases. From the academic significance, investigating cognitive psychology gains insight into the drivers of
investors’ behavior, and helps to construct
more accurate models to describe systematic
trading patterns than the efficient market
hypothesis. For the sake of investor wealth, to
understand their own behavior biases makes
them aware of what factors influence their
choice, providing them with useful equipment to improve trading decisions. In this
paper, we also make some recommendations
for the government, and policy makers to
improve and develop the Vietnamese security
market in the future.

The disposition effect is a direct result of an
investor’s trading behavior. It is the tendency
of investors to sell winning stocks too early
and hold losing stocks too long. For example,
when someone buys a stock at the price of
VND 10; this stock, however, declines dramatically. The general trend of people is not to
sell until the stock recovers above 10 VND
and is a reflection of the disposition effect.
The disposition effect is clearly a bias and
Journal of Economics and Development

2. Literature review

The disposition effect is considered to be
the implication of extending the prospect theory of Kahneman and Tversky’s (1979) to
investment in general and stock trading in par53

Vol. 14, No.2, August 2012

investors perform asymmetric risk aversion:
above that point, investors sell winners
because of risk adversion to gain and hold losers because of risk seeking in losses. On the
other hand, with mental accounting, people
divide prospects into separate accounts, executing prospect theory independently between
accounts as if there were no interaction
between them. Shefrin and Statmen also apply
the theory of self control in economics
(Thaler, 1981) to explain the disposition
effect. There are two parts in behavior: the
rational part, or the planner; and the emotional part, or the doer. That the doer tends to realize pride and keep away regret can conflict
with the rationality of the planner. As a result,
the lack of self control between the planner
and the doer hinders the investor from making
reasonable choices. The disposition effect, for
example, is a situation in which self control
exhibits: the doer has a more powerful impact
than the planner. By avoiding regret, the doer
holds on to the losing stocks too long.

ticular. Based on the rationale of prospect theory, Shefrin and Statman first documented the
concept of the “disposition effect” in 1985. In
this study, the authors propose that people
often keep away actions that create regret and
pursue actions that bring about pride. This
propensity allows investors to be predisposed
to realizing winners more readily than losers.
They are likely to sell winners too early since
they want to be proud of having achieved a
gain. They hold losing stocks longer since
they are afraid of selling right before an
increase in the price. Moreover, the feeling of
regret experienced by selling a winner to soon
is lower than the regret produced by holding
on a loser too long. However, the theory that
people avoid disappointment and strive for
pride does not provide a perfect explanation
for the disposition effect. It is highly likely
that regret can also exist in gains. For example, at a certain stock price, if the regret function weights more than the pride function for
an investor, he might not want to sell a winning stock. Furthermore, there is an asymmetry between the strength of pride and regret, as
regret is stronger. This leads to inaction over
action (Kahneman and Tversky, 1979). Such
an asymmetry would make investors reluctant
to realize both gains and losses. Thus pride
and avoiding regret can help understand the
disposition effect; but, it can only partially
explain the cause of disposition effect.

One year later (1986), the research of
Lakonishok and Smidt was an emerging one
documenting the disposition effect which took
into consideration the impact of tax. It is obvious that in most markets, short-term capital is
taxed at a higher rate than long-term.
Consequently, investors incline to sell losing
stocks in the short term in order to get more
tax refunds. Likewise, they will postpone realizing gains, waiting for the long term to take
advantage of lower income taxes incurred. If
investors behave for the sake of minimizing
taxes, trading would be predictable.
According to Lakonishok and Smidt, nevertheless, disposition effect predict an inconsis-

Other possible causes of the disposition
effect that are put forward by Shefrin and
Statmen are loss aversion, mental accounting,
and self control. The first explanation, loss
aversion, is a contribution of prospect theory.
There exists a reference point around which
Journal of Economics and Development


Vol. 14, No.2, August 2012

The disposition effect was first evidenced
in market data by Odean (1998). He investigated 10,000 discount brokerage accounts,
finding that individual investors demonstrated
a significant preference for selling winners
and holding losers, except in December when
tax motivated selling prevailed. The reason
for their behavior is neither to rebalance portfolio, nor to avoid the higher trading costs of
low priced stocks. He also analyzed the subsequent portfolio performance to find that it is
not justified to exhibit the disposition effect.
For taxable investments, it is subnormal and
leads to lower after-tax returns. More specifically, the extent to which this behavior affects
price movements depends on the trading
activities of major market participants such as
professional and institutional investors. Like
the findings of Lakonishok and Smidt (1986)
and Ferris et al. (1998), in the case the disposition effect exhibits in aggregate, it may create the positive relationship between price
change and trading volume.

tent image with tax predictions. They found
the positive relationship between stock prices
and trading volumes: winning stocks have
higher abnormal volume than losers. Then,
they proposed two resons for the disposition
effect. The first reason is portfolio rebalancing. A portfolio of assets will change over
time because some investments will increase
in value and others will decrease. The investments that have increased in value will begin
to have a larger weight in the portfolio while
the losing ones will take up less. In order to
maintain the original investment mix and risk
class, the portfolio needs to be rebalanced regularly. Thus, an investor will regularly sell
winning investments and hold on losing
investments in order to avoid his portfolio
changing its weight of asset classes.
Lakonishok and Smidt suggested another
cause for the disposition effect, and it is about
investors who buy stocks based on positive
information. They sell the stock when the
price goes up, thinking that such increase has
reflected their initial information. They will
keep holding the stock if the price goes down
believing that the stock has not yet reflected
their information.

The method of Odean to find the disposition effect in market data has limitations
because we cannot take into consideration
investor expectations and individual decisions. The results found in aggregate market
data may stem from the statistical factors but
not the behavioral ones. Weber and Camerer
(1998) fixed this shortcoming by using experimental evidence: they examined individual
trading decisions in controlled experiments,
detecting the disposition effect directly. The
result revealed that people use purchase prices
to be the reference point: they sell more often
the winning stock (the price above purchase
price) than the losing stock (the price below

Ferris et al. (1998) contributed another reason to explain the disposition effect: the trading costs. In this study, the author compared
two models of trading in equities: tax loss
selling and the disposition effect. This is analogous to Lakonishok and Smidt’s comparing
tax predictions and the disposition effect.
Ferris et al. produced the opposite result with
tax loss selling effects and a consistent result
with disposition selling effect when trading
volumes and returns are positively correlated.
Journal of Economics and Development


Vol. 14, No.2, August 2012

purchase price). It is suggested by the author
that people misperceive future price changes
because of the influence of mean reversion.
Weber and Camerer used prospect theory as
the second reason for the disposition effect:
people are reluctant to record losses because
they are risk seeking in loss and risk averse in
gain of the S-shaped value function.

In Finland’s stock market, Grinblatt and
Keloharju (2001) discovered the exhibition of
the disposition effect for both individual and
institutional investors. Also, past price patterns do affect the trading volume in this stock
market. Disposition effect was also found in
American residential real estate market by
Genesove and Mayer (2001). The study of
Dhar and Zhu (2002) on individual investors
also found the same result. Such investor
characteristics such as education, account levels, and trading experiences are found to play
critical roles in the level of the disposition
effect. It reveals that more educated, wealthier, and more frequent investors are less
exposed to the disposition effect. Analyzing
the disposition effect at the individual level,
can identify more factors which contribute
to the disposition effect, assisting investors
with better decisions.

In the second experiment, Weber and
Camerer let subjects sell all shares in their
account automatically at the end of the investment period. However, participants could purchase those stocks back in the next period
without any transaction costs. The result was
that participants exhibited less of a disposition
effect. In other words, they chose not to buy
back the losing stocks. When participants
have to decide for themselves while still owning the shares if they continued to hold the
stock or not, they are subject to gambler’s fallacy, as they blindly believe in mean reversion. This experiment proposed self control as
the reason for the disposition effect.

It is noticeable that the disposition effect
described above has been mainly in Western
cultures. However, there may be psychological differences between Asian cultures such as
those of Korea, China, Singapore, and
Vietnam. According to Hofstede (1980), cultural differences are frequently expressed in
cognitive studies as an individualism- collectivism continuum. The collectiveness of Asian
society vs. the individuality of Western society leads to the difference in perception of risk
in the two cultures. A loss incurred by an individual in Asian countries can be shared by
family members while it is not often the case
in Western ones. Moreover, the fact that the
Asian education system encourages students
to follow but not criticize makes their
investors more overconfident. It is highly like-

A lot of research applies the previous study
to detect the disposition effect in other markets up to now. Zur Shapira and Itzhak
Venezia (2000) researched the disposition
effect in Israel’s stock market. Their results
demonstrate that the disposition effect exists
not only at individual but also at the institutional level. However, the professionals
exhibit less disposition effect compared to
individuals as they have better education and
better experience. Also, they suggest that market microstructure models assume the presence of irrational and rational traders and
could be enhanced by incorporating investors
with varying degrees of biases or information.
Journal of Economics and Development


Vol. 14, No.2, August 2012

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