The Disposition Effect and Underreaction to News



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    • Graduate School of Business, University of Chicago. This paper is based on a portion of my thesis at Yale University. A special thanks to Owen Lamont and Nick Barberis for invaluable discussions, encouragement, and for insightful comments. Thanks also to the referee, Robert Stambaugh (the editor), Bob Shiller, Will Goetzmann, Riccardo Puglisi, Sigridur Benediktsdottir, Antti Petajisto, Judy Chevalier, Richard Mendenhall, Langdon Wheeler, Myron Scholes, Kent Daniel, Jeremy Stein and Toby Moskowitz, and to seminar participants at Yale University, the University of North Carolina, the Chicago Quantitative Alliance, Numeric Investors, Oak Hill Platinum Partners, Ziff Brothers Investments, the University of Pennsylvania, Goldman Sachs Asset Management, the University of Chicago, Cornell University, the Massachusetts Institute of Technology, New York University, Stanford University, Fuller & Thaler Asset Management, Northwestern University, Harvard University, Columbia University, and the Eastern Finance Association Meetings. I gratefully acknowledge financial support from the Yale International Center for Finance, the Whitebox Advisors Doctoral Fellowship, and the Chicago Quantitative Alliance 11th academic competition. All errors are of course solely mine.


This paper tests whether the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post-announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event-driven strategy based on this effect yields monthly alphas of over 200 basis points.