A Dynamic Model of Investor Decision-Making: How Adaptation to Losses affects Future Selling Decisions

Carmen Lee, Roman Kraeussl, Andre Lucas and Leonard J. Paas
Additional contact information
Carmen Lee: Marketing Department, VU University Amsterdam
Roman Kraeussl: Finance Dept., VU University Amsterdam
Leonard J. Paas: Marketing Dept., VU University Amsterdam
Authors registered in the RePEc Author Service: Roman Kräussl

No 08-112/2, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We conduct an experiment to test whether the size of a loss and the time in a losing position affect investors’ adaptation to the loss situation and, subsequently, whether this adaptation affects future investment decisions. As investors adapt to losses, their neutral reference point shifts downwards causing losses to become psychologically less painful. This shift in reference point is a dynamic process that is updated every time new information is received about the stock’s performance. The dynamically changing reference point, together with changing perceptions on the stock’s expected future performance, together influence the decision to hold on to or to capitulate on an investment. We study the relative contribution of each of these components as well as their inter-relationships in a dynamic experimental design. Our results indicated that a larger loss size and a longer time in a losing position are related to higher adaptation levels. These higher adaptation levels relate to less positive emotions and less optimistic expectations about future price changes. The actual decision to capitulate an investment, however, only depends directly on the expectation about the stock’s future performance. The adaptation level, by contrast, affects the actual investment decision indirectly via its impact on expectations.

Keywords: adaptation; capitulation; selling decisions; investment (search for similar items in EconPapers)
JEL-codes: C91 D03 D81 (search for similar items in EconPapers)
Date: 2008-11-17, Revised 2013-09-02
New Economics Papers: this item is included in nep-cbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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