An experience from her own life inspired Siria Xiyueyao Luo’s research. The PhD candidate at Vrije Universiteit Amsterdam noticed that she held onto losing stocks for much longer than would be rational. She observed the same behaviour among other investors in stock markets, resulting in significant financial losses. But what is the cause of this behaviour? Through various experiments, Luo discovered that the hope of still breaking even is an important explanatory factor.
In one of the experiments, Luo asked participants to reflect on various statements, to find out how hopeful they were. Participants were then asked to invest in (fictional) stocks, which would continuously decrease in value. It turned out participants hold onto different forms of hope, and these differences correlated with investment behaviour.
Two types of hope are relevant here: the hope to make a profit and the hope to break even. The participants were split in two groups. In one of the groups, the value of the stock was stable. In the other, the value dropped. Both groups had a hope to win, but in the second group Luo also observed a hope to break even. This hope to break even drives them to keep the losing stocks.
Luo explains: "In my research, I look at how emotional factors, such as hope, can explain behaviour that is not really rational. In the case of losing shares, we do know that there is a high probability that our loss will only increase, but people still cling to the hope that the value will still rise again to its purchase value. After all, there is no evidence that it is impossible, even though the probability is very low."
People who are generally more hopeful are more likely to hold losing stocks for too long. And there is also a higher risk if you have little experience. "Therefore, it is important that young people are aware of this 'disposition effect' and learn how to guard themselves against it." said Luo.
One way to guard yourself is to make an agreement with yourself before you start investing: “If the stock falls below a certain value, I will sell it.” There are even online platforms where you can set such a ‘quitting rule’. Having someone else manage your shares might also help, according to an additional experiment by Luo. “We divided participants in two groups: one group had to manage their own shares, while the other group had to manage those of an anonymous client. The people who managed an anonymous client's shares dared to sell a losing share much faster than those who managed their own shares.”
Luo is currently finalizing her PhD thesis, which covers several other experiments on the theme of hope. Would you like to know more about research at the VU School of Business and Economics? Contact science editor Yrla van de Ven, y.f.van.de.ven@vu.nl or 06-26512492.