DP4814 Disposition Matters: Volume, Volatility and Price Impact of Behavioural Bias

Author(s): William Goetzmann , Massimo Massa

Publication Date: December 2004

Keyword(s): disposition effect , asset prices , volatility

JEL(s): D10 , G10

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP4814.asp

We test the market impact of the disposition effect. We rely on the Grinblatt and Han (2002) model and derive testable implications about the expected relationship between the preponderance of disposition investors in the market and stock volatility, return and trading volume. We use a large sample of individual accounts over a six-year period to construct a variable that acts as proxy for the representation in the market of disposition investors. We show that, at a daily frequency, when the fraction of ‘irrational’ investor trades in a stock increases, stock volatility, return and trading volume decrease. We further show that such a stock-specific disposition acts as proxy to aggregates at the market level, generating a common factor. Statistical exposure to such a disposition-related factor explains cross-sectional differences in daily returns, after controlling for a host of other factors and characteristics.