Behavioural Finance Case Study

Two-fold analysis

Examine the extent to which the disposition effect is present in the equity trades of mutual funds. Investigate how the disposition effect influences mutual funds’ investment style and performance.
Behavioural Finance Case Study
The Prevalence of the Disposition Effect in Mutual Funds’ Trades
ZHANG XIAONING
ZHANG WEICHAO
XU YANG
Outline

The research question Methodology used Main results
Methodology
• Detection of Disposition-Driven Behaviour
• Calculate the disposition spread • Create Metric of disposition ratio for Cross-Fund Comparisons
Q1. Why a substantial fraction of mutual funds exhibits the disposition effect? Q2. How do investors react when they are under pressure to act on their investments? Q3. Whether the teams have on disposition-prone behavior?

Implications
The research question

With skillful and experienced experts and superior technologies, U.S. equity mutual funds, on average, prefer realization of capital losses to capital gains.
Main results 2
Influences of the disposition effect on funds’ style and performance
Style • Lower market betas • Higher loadings on the book-to-market equity common risk factor is consistent with a value-oriented investment style • Lower (negative) loadings on the momentum factor is consistent with a short-term contrarian investment style Performance • No evidence that the disposition effect will have a negative impact on fund performance • The power of test may be limited by the quarterly frequency of trading extrapolated from quarterly holdings – study of more frequent data may indicate otherwise
Heterogeneity among sample results (22-55%)
• Persistent in the behaviour • Tend to add to losses More likely to be affected by the disposition effect when under pressure Funds managed by teams are more susceptible to disposition effect
Methodology
Data Sources and Sample Construction
• Portfolio holdings data for U.S. equity mutual funds from January 1980 to December 2009 came from Thomson/CDA
Methodology
Table 3. Proportion of Realized Gains and Losses by Type of Fund
Table 4. Logit Regression on Sell versus Hold Decision
Methodology
Table 5. Characteristics of Decile Portfolios Formed on DISP RATIO
Main results 1
Prevalence of disposition effect in US equity mutual funds’ trading
No aggregate tendency to realise gains ggesting that mutual funds serve as potential mitigators of distortions caused by retail investors
Implications of the study
For investment managers

For investors

Recognition of the disposition effect Self-assessment questions:

Real style vs. claimed style of a mutual fund

To what extent am I influenced? Is such influence justified?

E.g. claimed to be growth fund, but can be tilted towards value
E.g. value strategy, contrarian strategy Performance analysis
Methodology
Table 1. Proportion of Realized Gains and Losses Table 2. Proportion of Realized Gains and Losses by Subperiod
Figure 1. Large versus Small Families by Subperiods

Risk management procedures Performance record

Techniques to isolate trading decisions from the disposition effect
• Examination of the relation between disposition-driven behavior and portfolio style and performance
• Rank funds into deciles based on their disposition ratio in quarter t-1 at the beginning of each quarter t • Funds in each decile are placed into portfolios and held for 3 months, with the same ranking procedure and portfolio updating repeated every quarter. • After creating time series of monthly returns of the decile portfolios, evaluate their style characteristics and performance with the Fama and French (1993) and Carhart (1997) models