Title: DISPOSITION EFFECT OF INVESTORS ON INVESTMENT DECISION MAKING: EXPLANATION OF REGRET REGULATION AND REGULATORY FOCUS

Author: I Made Surya Negara Sudirman

Item Type : Thesis (Thesis)

Affiliations: Doctoral Study Program in Management Science, Faculty of Economics and Business, Universitas Airlangga , Surabaya, Indonesia

Publisher: Universitas Airlangga

 

Abstract

The disposition effect is the tendency of investors to sell shares that perform superiorly early, and hold too long shares that perform inferiorly (Shefrin and Statman, 1985). The disposition effect has become a widely researched phenomenon because this phenomenon has an impact on the loss of potential profits that could be obtained by investors when share prices are still increasing, and the greater the potential losses that investors will suffer when share prices continue to decline. Previous researchers have offered various different explanations, but until now there are still several questions left unanswered. Prospect theory (Kahneman and Tversky, 1979) and regret theory (Loomes and Sugden, 1982; Bell, 1982) are the two theories most widely used by researchers to explain the disposition effect phenomenon. Prospect theory provides an explanation based on the concept of loss aversion, while regret theory provides an explanation based on the concept of anticipated regret. Loss aversion makes investors sell superior performing stocks too early, and loss aversion makes investors hold inferior performing stocks too long. Anticipation of regret makes investors sell superior performing stocks too early and anticipated regret makes investors hold inferior performing stocks too long. Even though both theories are quite good at explaining the disposition effect, they both have weaknesses, leaving several questions unanswered. Prospect theory and regret theory fail to answer several questions, including: what conditions determine investors to sell superior performing stocks early? Do investors always respond to every price increase with the decision to sell the superior shares they own? What conditions determine investors holding inferior performing stocks for too long? Are investors still willing to hold inferior stocks when prices continue to decline, resulting in increasingly large losses? (Sudirman, et. al. 2017) To answer these questions, the theoretical model in this research was built by considering: regulatory focus factors, level of gain, level of loss and level of share price volatility. This research model was built based on Regret Theory (Loomes and Sugden, 1982; Bell, 1982); Regret Regulation Theory (Zeelenberg and Pieters, 2007; Pieters and Zeelenberg, 2007); Regulatory-Focus Theory (Higgins, 1997; 1998) and several hypotheses, including: Leverage Effect Hypothesis (Black, 1976; Christie, 1982); Volatility Feedback Hypothesis (Pindyck, 1984; French et al. 1987). In this research, two models were built, namely model 1 and model 2. Model 1 is a model that explains the main effects and interaction effects between variables which have consequences for the disposition effect in the gain domain. Model 2 is a model that explains the main effects and interaction effects between variables which have consequences for the disposition effect in the loss domain. The research method used in this research is true experimental, carried out in the laboratory, with a 2x2x2 mixed factorial design for each model, model 1 and model 2. The mixed factorial design in this research consists of one factor between subjects and two factors within subjects . Model 1 consists of: regulatory focus factors as between subject factors, and gain level and volatility levels as within subject factors. Model 2 consists of: regulatory focus factors as between subject factors, and loss level and volatility levels as within subject factors. The sample in the study consisted of 60 participants for each model which was selected using a simple random sampling method, by previously determining the target population and accessible population. Data analysis in this study used mixed three way ANOVA ANOVA, which is a complex ANOVA model for analyzing a model consisting of one between factor and two within factors. The post hoc test in this study was carried out using the Bonferroni Test. The results of this research show that the regulatory focus factors, level of gain, level of loss, and level of volatility, influence differences in investors' disposition effect levels. The main effects of regulatory focus factors, level of gain and level of volatility show that these three factors significantly determine the level of disposition effect in the gain domain. The main effects of the regulatory focus factors, level of loss and level of volatility show that these three factors significantly determine the level of disposition effect in the loss domain. Individually, the level of gain and level of loss are the main factors that can explain the greatest variability in the disposition effect. The three-way interaction effect between the type of regulatory focus, level of gain, and level of volatility gives rise to a unique effect in model 1. The unique interaction effect in model 1 explains that promotional focus investors tend to choose risky options, when the level of gain is low and the level of volatility is consequently low. on decreasing the disposition effect. Conversely, when the level of gain is high and the level of volatility is high, promotion-focused investors tend to choose riskless options, which has the consequence of increasing the disposition effect. The unique interaction effect in model 1 also explains that prevention-focused investors are more susceptible to the disposition effect than promotion-focused investors, when the level of gain is small and the level of volatility is low. Conversely, when the level of gain is large and the level of volatility is high, promotion-focused investors are more susceptible to the disposition effect than prevention-focused investors. The three-way interaction effect between the type of regulatory focus, level of loss, and level of volatility gives rise to a unique effect in model 2. The unique interaction effect in model 2 explains that prevention-focused investors tend to choose risky options when the level of loss is low and the level of volatility is low which has consequences on increasing disposition effect. On the other hand, when the level of loss is high and the level of volatility is high, prevention-focused investors choose riskless options, which has the consequence of reducing the disposition effect. The unique interaction effect in model 2 also explains that prevention-focused investors are more susceptible to the disposition effect than promotion-focused investors, when the level of loss is small and the level of volatility is low. On the other hand, when the level of loss is large and the level of volatility is high, promotion focused investors are more susceptible to the disposition effect than prevention focused investors. The results of this research provide a more sophisticated explanation of the disposition effect, by answering questions that have not been answered in the theoretical explanations of previous researchers. Besides providing a more sophisticated theoretical explanation than previous studies regarding the causes of the disposition effect, this research also has theoretical implications for the new paradigm of risk preference as a tactic. In conventional finance based on expected utility theory, risk preference is seen as a trait, and every investor is assumed to be risk aversive. In behavioral finance based on prospect theory, risk is viewed as a trait determined by prospects. Prospect theory states that in a profitable prospect or gain domain investors are risk averse, while in a detrimental prospect in a loss domain investors are risk seekers. In the theoretical model of this research which is based on Regret Theory, Regret Regulation Theory, Regulatory Focus Theory and several hypotheses, including: Leverage Effect Hypothesis and Volatility Feedback Hypothesis, risk preference is seen as a tactic. Where in the gain domain and loss domain, investors can choose risk aversion and risk seeker tactics, depending on the type of regulatory focus they have and the conditions they face. Promotion-focused investors have regulatory fit in the gain domain, tend to anticipate regret by choosing risk-seeking tactics, when the expected profits have not been achieved. On the other hand, promotion-focused investors tend to anticipate regret by choosing risk aversion tactics, when the expected profits have been achieved. Prevention-focused investors who have regulatory fit in the loss domain tend to anticipate regret by choosing risk-seeking tactics, when the losses suffered can still be tolerated. On the other hand, prevention-focused investors tend to anticipate regret by choosing risk aversion tactics, when the losses suffered can no longer be tolerated. The latest explanation regarding the disposition effect phenomenon and a new paradigm related to risk preferences are the main novel contributions in this research. The integration in this research is expected to contribute to the development of behavioral finance science, the development of best practices for capital market practitioners, and as a basis for consideration for capital market regulators in formulating policies.

Keywords: disposition effect, regulatory focus theory, regret regulation theory, regret theory

 

Sources: http://repository.unair.ac.id/77388/