Disposition effect and momentum based on prospect theory/mental accounting in the Chinese stock markets

Abstract

The disposition effect, which is first introduced by Shefrin and Statman (1985), refers to the tendency of individuals to profit their gaining transactions (winners) too early and the reluctance to realize their losing transactions (losers). The main purpose of this dissertation is to analyze the relation between the disposition effect and momentum in the Chinese stock markets under the framework of the prospect theory and mental accounting (PT/MA). The sample contains a cross-sectional weekly data for 1,022 stocks with the sample period from January 1991 to November 2008. To measure the relation between the disposition effect and momentum, this dissertation follows the Grinblatt and Han (2002, 2005) model to use unrealized capital gains overhang which is based on past prices and stock volume to estimate the disposition effect. By using double sorting method and cross-sectional Fama-MacBeth (1973) regressions, the findings of this dissertation do not suggest that the unrealized capital overhang is positively related to the future returns. More interestingly, this dissertation finds that there is no significant intermediate horizon momentum effect and there is no evidence to support that the disposition effect drives momentum in the Chinese stock markets.