Market states and disposition effect: evidence from Taiwan mutual fund investors

Abstract

We study the disposition effect across market states in the context of mutual fund investors in Taiwan. Using mutual fund data at the fund and individual levels during July 2001 to October 2008, we find that the disposition effect varies across market states. Our results suggest that investors redeem their mutual fund units more under a bear market than a bull market when they have extreme capital losses. When investors have moderate capital gains, they are less active in redeeming their mutual fund units under a bull market relative to a bear market. Under a neutral market, investors actively redeem mutual fund units in both winner and loser mutual funds except when they have extreme capital losses. Thus, disposition effect is not uniform; it varies by market condition. In addition, the disposition effect phenomenon also exists for Taiwan mutual fund investors as well. Our findings are robust to aggregate and individual investor levels.

Keywords:

• market states
• disposition effect
• mutual funds
• behavioural finance

JEL Classification::

• G15
• G10

Notes

¹ Pagan and Sossounov (2003) propose using a minimum of 4 months between the peak and the trough. The 4-month window is also supported by Hamilton (1919) and Edwards et al. (2003).

² The actual periods of the first bull market was from April 2000 to September 2001 with a cumulative return of −63%. In order to meet our sample (July 2001 to October 2008) to match the mutual fund individual data, we cut apart of the first bull market periods from our sample beginning date July 2001 to the ending date of first bull market periods September 2001.

³ Other research is on the following: RED is used in O’Neal (2004) and Lee et al. (2010); MAR is cited from Garvey and Murphy (2004) and Frazzini (2006); LNSIZE and MASTD are cited from Sirri and Tufano (1998) and Shu et al. (2002); TOR and FEE_M are cited from Cici (2005), Chevalier and Ellison (1997) and Jain and Wu (2000).

⁴ When mutual fund investors redeem their units, the fund size drops or vice versa.

⁵ The significantly positive coefficient of loser mutual funds (β ₄ and β ₅) stands for that investors redeem their mutual fund units less in relative to the insignificantly coefficient of loser mutual funds.