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Thursday, April 27, 2023

A dark side of hope: Understanding why investors cling onto losing stocks

Luo, S. X., et al. (2022).
Journal of Behavioral Decision Making.


Investors are often inclined to keep losing stocks too long, despite this being irrational. This phenomenon is part of the disposition effect (“people ride losers too long, and sell winners too soon”). The current research examines the role of hope as a potential explanation of why people ride losers too long. Three correlational studies (1A, 1B, and 2) find that people's trait hope is positively associated with their inclination to keep losing stocks, regardless of their risk-seeking tendency (Study 2). Further, three experimental studies (3, 4, and 5) reveal that people are inclined to hold on to losing (vs. not-losing) stocks because of their hope to break even and not because of their hope to gain. Studies 4 and 5 provide process evidence confirming the role of hope and indicate potential interventions to decrease people's tendency to keep losing stocks by reducing the hope. The findings contribute to the limited empirical literature that has investigated how emotions influence the disposition effect by providing empirical evidence for the role of hope. Moreover, the findings add to the literature of hope by revealing its role in financial decision-making and show a “dark side” of this positive emotion.

General Discussion

Investors are reluctant to sell their losing stocks, which is part of the well-known disposition effect (Shefrin & Statman, 1985). Why would investors do so, especially when it is a suboptimal financial decision? In a series of studies, we found consistent support for the idea that the emotion of hope explains at least partly why people hold on to their losing stocks. Studies 1A and 1B revealed that an increase in people's trait hope (measured by two trait hope scales) increases their inclination to keep losing stocks. Study 2 further confirmed that the trait hope is positively associated with the inclination to keep losing stocks, controlling for the influence of the risk-taking tendency of real-world investors. In Study 3, we developed a simple and effective experimental design to examine whether losing influences hope and people's tendency to keep stocks in the same way. In addition, it differentiated between what people hope for: to break even versus to gain. The results indicate that when one's stocks are losing, compared with when they are not, people experience a stronger hope to break even and an inclination to keep, but not a stronger hope to gain. In addition, Study 3 found that losing (vs. not losing) leads to a stronger inclination to keep stocks.

Moreover, the hope to break even (but not the hope to gain) mediated the effect of losing on the inclination to keep. Study 4 found that reducing people's hope to break even decreases their inclination to keep their losing stocks to the same level as when their stocks did not decrease in price. Study 5 found that people tend to have a lower hope to break even when holding stocks on behalf of others (vs. for themselves) and thus tend to be less likely to keep the losing stocks. Studies 4 and 5 provided process evidence that reducing hope attenuates the inclination to keep, suggesting two possible interventions focusing on the possibility or the desire feature of hope. In a series of studies, we found that people cling to losing stocks because they hope to break even, and reducing this hope decreases their inclination to keep the losing stocks.