Academic journal article Business and Economics Research Journal

Holding Periods, Illiquidity and Disposition Effect in a Developing Economy

Academic journal article Business and Economics Research Journal

Holding Periods, Illiquidity and Disposition Effect in a Developing Economy

Article excerpt

Abstract: This paper aims to empirically investigate holding periods, illiquidity and disposition effect in Karachi Stock Exchange (KSE). KSE 100 Index Companies daily data were collected for a period of five year i.e. 2003-2007. Daily returns, holding periods, illiquidity and volatility were calculated through this data. These variables were regressed in models used by Visaltanachoti et al. (2007) to calculate annual holding periods, illiquidity and disposition effect. The results have revealed that there exists disposition effect in KSE. Holding periods were found positively related to illiquidity and negatively associated with stock returns. Further, holding periods were long for illiquid stocks and short for less illiquid stocks. The study is significant in the sense that it's perhaps the first study conducted in a developing country like Pakistan.

Keywords: Disposition effect, illiquidity, holding periods, Anomaly, KSE

JEL Classification: D03, D80, G11.

(ProQuest: ... denotes formulae omitted.)

1. Introduction

Investors sell winning stocks too early while holding losing stocks too long is termed as disposition effect. There are many explanations for this anomaly. According to Prospect theory, investors weight their losses more than gains which results in lingering losses. Based on this theory, disposition effect was initially proposed by Shefrin and Statman (1985). According to Shefrin and Statman (1985), the disposition effect refers to the inclination to sell previously purchased stocks that have appreciated in value and the reluctance to sell those that are trading below their purchase price. It's not necessary that investors use their purchase price as reference point; it may be different from one investor to another.

This study attempted to explore the holding periods, illiquidity and disposition effect in Karachi Stock Exchange 100 index companies. The result shows that disposition effect is present in Karachi stock exchange 100 index companies. Holding periods are inversely associated with stock returns. This association shows that investors sell winning stocks soon and hold losing stocks long (disposition effect). These results are in line with Visaltanachoti et. al. (2007).

Remainder of this paper is arranged as: introduction is followed by literature review which discusses different studies conducted in different scenarios and environments on disposition effect. Then methodology highlights the data and procedures used in this study. After that results and discussion precede causes of disposition effect, conclusion and practical implications.

2. Literature Review

Investors sell winning securities too earlier while holding losing securities too long was referred as disposition effect by Shefrin and Statman (1985). Their work was based on Prospect theory proposed by Kahneman and Tversky (1979). Prospect theory states that investors weight losses more than gains. This phenomenon is also called loss aversion. Shefrin and stateman mounted the disposition effect on this loss aversion bias. In simple words when prices appreciate investors sell their securities hastily and when prices depreciate they are very reluctant to sell their securities.

Numerous studies have been conducted to test disposition effect, either this exists or not and at what intensity in different markets and in different scenarios. Disposition effect is more for internal investors than the external ones and it is prominent even in the absence of belief in mean reversion theory (Chui, 2001). Jordan and Diltz (2004) tested disposition effect among day traders and found that traders' attitude after loss is more risk seeker and they try to offset their prior loss. Their findings support the existence of disposition effect. Garvey and Murphy (2004) found disposition effect in professional traders. They ascertained that a fund manager can earn even more if he/she be not guilty of disposition effect. …

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