Sophistication of Individual Investors and Disposition Effect Dynamics

This paper analyses the disposition effect at an individual level by studying the trading records of 20 379 investors over 1999-2006. As in previous studies, we confirm a huge heterogeneity among investors and we propose to explain these differences on the basis of financial sophistication and trading behavior proxies. In our new approach, we use direct sophistication variables: trading of foreign assets, derivative assets and bonds as well as trading on both tax-free and traditional accounts. We show that these variables significantly reduce the level of the disposition effect. Furthermore, based on a dynamic panel data analysis, we question investors’ ability to correct their bias over time. Results show that individual investors’ disposition effect decreases over time and that this decrease is partly caused by sophistication variables.