is known as the disposition effect. Investors impacted by the disposition effect are more likely to sell winning stocks too early and hold on to losing stocks for too long.
The disposition effect is well known to be costly to investors, at least in the U.S., for two reasons. First, it's known that past winning stocks continue to perform better than past losers. Second, selling winning stocks is associated with capital gains taxes. According to new research from Wang, the disposition effect holds if an investor's entire portfolio is at a loss but significantly weakens if the portfolio is at a gain. The finding highlights that investors will be more likely to sell profitable stocks when their portfolio is at a loss, compared to being more likely to hold on to winning stocks when their portfolio is at a gain.
The researchers explore additional predictions based on their mental accounting-based framework. Mental accounting-based theories predict that investors tend to group similar assets into one mental account and less similar ones separately. Different mental accounts will not be fully fungible even if without any physical constraints.
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