A Portfolio Rebalancing Theory of Disposition Effect

Prof. Liu Hong

Professor of Finance
Washington University in St.Louis

About the Speaker

Professor Liu Hong is currently Professor of Finance in Washington University in St. Louis, where he has been Academic Director of the Master of Science in Finance Program since 2008. Professor Liu’s research areas include optimal consumption and investment with frictions, asset pricing, and market microstructure. He has published in Journal of Finance,Journal of Financial Economics, Review of Financial Studies, Journal of Economic Theory, and other leading academic journals. Professor Liu is the recipient of Management Science Distinguished Service Award (2013), TCFA Best Paper in Investment (2013), TCW Best Paper Award (2011), etc. Professor Liu has also been on the editorial board of top international journals, including Review of Finance and Management Science.

He is visiting RMI from 2 June to 15 June 2016 as the NUS-RMI Professor in Risk Management.

About the Seminar

The disposition effect (i.e., the tendency of investors to sell winners while holding on to losers) has been widely documented, and behavioral explanations have dominated the extant literature. In this paper, we develop a portfolio rebalancing model with transaction costs to explain the disposition effect. We show that almost all of the disposition effect patterns found in the existing literature are consistent with the optimal trading strategies implied by our model, with or without capital gains tax. In addition, selling winners that tend to subsequently outperform held losers can be optimal.

This is a joint work with Min Dai from National University of Singapore and Jing Xu from Renmin University.