What is the “disposition effect” in investment behavior? (5 points) Explain why “disposition effect” could cause stock price momentum (the momentum effect)

Generally we see, Investors want to invest in those stocks/ assets, where he foresees upward movement in near future and wants to sell those stocks which are not showing movement from the long time or going down continuously and there is a not any sign of uplift. It is a rational behaviour shown by investors.

But in " Disposition Effect" investors reluctant to sell assets that have lost vlaue and greater likelihood of selling assets that have made gain.

This phenomenon can be explained by prospect theory,regret avoidance and mental accounting.In this case , investors want to avoid losses at any cost, so they exhibit risky behaviour by holding onto duff shares.

A more behavioural explanation of momentum is based on disposition effect. It refers to investors' behaviour to sell the winning stocks and hold the losers stocks for long time.

Investors who suffer from disposition effect will tend to underreact to news and would show eagerness to make profit, selling their assets ( in case of good news).

Thus he pushes the market price below its fundamental value and generating a spread. In that period movement will continue and keeping the spread until the fundamental value is reached.

The convergence of this spread is interpreted as momentum and would happen in the opposite direction face to bad news.