Abstract:
Disposition Effect, which has been popularized and well documented as
one of the various explanations for the persistence of momentum in the
returns of the stocks over various time horizons was first documented by
Shefrin and Statman (1985). Accordingly, the disposition effect refers to
the tendency of investors to realize their profits too early and reluctance
to realize their losses that arise out of changes in stock prices. The
downward pressure on the prices of winner stocks due to higher growth in
trading volume could lead to a price reversal, which ultimately results in
losers outperforming winners for a specific time. This price reversal
tendency could be influenced by many factors of which some are
observable and, some, unobservable. Consideration of observable factors
while disregarding those unobservable variables may result in producing
biased and counterintuitive estimates by cross sectional and time series
analyses. Based on the studies by Cressy and Farag (2009, 2010) this
study examines by using Fixed Effects Model which takes unobservable
factors into consideration, whether past losers outperform past winners.
Using daily data from the Sri Lankan stock market, a sample of 20 stocks
that faced a drastic 1 day price change was taken to examine price
reversals. Even though cross section and pooled regression results yield
insignificant results, fixed effects model strongly supports price reversals
of the winning and losing stocks. These results suggest that the
unobservable time specific together with firm specific factors play a
major role in explaining price reversals in the Sri Lankan stock market.
