Summary: The disposition effect is an anomaly discovered in behavioral finance. It relates to the tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value. Investors are less willing to recognize losses (which they would be forced to do if they sold assets which had fallen in value), but are more willing to recognize gains.

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THE DISPOSITION EFFECT: DO NEW ZEALAND INVESTORS KEEP THEIR MISTAKES?

This paper tests the disposition effect (the tendency of investors to show a preference towards realising winning investments over losing investments) in New Zealand by analysing 125 trading accounts from a nationwide retail brokerage house between 1st June 1988 and 30th April 1999. Our analysis differs from Odean’s (1998) earlier test in three ways: 1) the data is from a retail brokerage allowing investors the benefits of professional advice; 2) New Zealand has no capital gains tax thus taxation does not cloud selling decisions; and 3) the New Zealand market environment in this period is relatively flat unlike the U.S. The analysis is performed using two different reference points for measuring winning investments and losing investments.

Firstly, the average purchase price of the security is used and secondly, a relative strength measure is employed to indicate the recent performance of the security. Overall, the investors tend not to exhibit characteristics of the disposition effect, when the average purchase price is used as a reference point from which to evaluate winners and losers. When the relative strength measure is used on the same data set, the investors tend to exhibit a slight disposition effect, which is driven by the more frequent traders in the data set. However, this disposition effect weakens once the data set is expanded to include addition sales for which the purchase price is unknown.

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