Disposition Effect

What it is

The book discusses mental accounts, the separate ledgers people keep for money and for projects. It calls mental accounts a form of narrow framing, and names the disposition effect as one of the places where the habit shows. An investor with a rising stock and a falling one has two accounts. Selling the first closes an account at a gain. Selling the second closes one at a loss.

Hersh Shefrin and Meir Statman named the pattern in 1985, in the Journal of Finance. Their abstract places the reluctance to realize losses within a broader tendency to sell winners too early and hold losers too long, and ties it to mental accounting, regret aversion, self-control and tax considerations. They argue that taxes alone cannot explain it, and that the concentration of loss realizations in December fits their theory and not fully rational behaviour.

Terrance Odean tested it on trading records in 1998. His abstract reports 10,000 accounts at a large discount brokerage and a clear preference for selling winners over losers. Rebalancing needs and the higher trading costs of low-priced stocks did not explain it, and later portfolio performance did not justify it. In taxable accounts the behaviour lowered after-tax returns. Another reading in the vault, that selling a loser makes the loss real and proves the purchase was a mistake, comes from a different book and is not tested here.

In effect

The practical reading, in the book's terms, is that two holdings are being treated as two separate decisions when they are one portfolio. A broad frame asks what the whole set of holdings should look like, and which sale improves it, whatever each holding's history.

The effect belongs with the other cases in the book where the same narrow frame operates. Mental accounting is one. The sunk cost fallacy is another, because a spend only counts as a reason to continue when it is sealed off from what else the money or time could do. Each is the narrow frame seen from a different side.

What it does not say

It does not say that selling winners is always a mistake. Odean's abstract finds that the pattern is not rescued by rebalancing needs or trading costs, and that later portfolio performance does not justify it, but the finding concerns the average investor in one set of accounts and not any one sale.

It does not come with a figure on this page. The figures in the vault's note from another book were not found in the abstracts read, so they are left out.

Only the abstracts of the two papers were read. The wider replication record has not been assessed here, so the evidence status is primary-cited and not robust.

---