How Prior Realized Outcomes Affect Portfolio Decisions
36 Pages Posted: 22 Feb 2013 Last revised: 25 Feb 2013
Date Written: February 20, 2013
Investors have been shown to have particular preferences when it comes to the characteristics of stock they hold in their portfolios, while prior gains and losses have been shown to impact on individuals’ economic decisions, both in an investment context and more widely. This paper is the first to investigate how prior gains and losses affect investors’ preferences for particular stock characteristics and so shape their portfolio compositions. Using a rich dataset combination from China, we conclude that prior realized outcomes play an important role in shaping portfolio composition through their impact on the characteristics of stocks that investors choose to hold. We find that positive prior realized outcomes encourage investors to select stocks with a variety of characteristics broadly consistent with higher risk taking (for example, higher betas and higher levels of idiosyncratic risk), though there are some differences across investor classes. While our empirical results are in line with what one would expect from the existing literature on the disposition and house money effects, we also consider other possible interpretations of the results.
Keywords: prior realized outcomes, stock characteristics, portfolio composition
JEL Classification: G10, G11
Suggested Citation: Suggested Citation