CFA Level I · CFA Level I Exam · The Behavioral Biases of Individuals
An investor refuses to sell a stock that has fallen 30% below her purchase price, saying she will sell once it "gets back to even." Meanwhile she quickly sells her winning holdings to lock in small gains. This behavior is most likely a result of:
The behavior is most likely loss aversion. Investors feel losses more strongly than equal gains, so they avoid realizing losses by waiting to break even and rush to sell winners. This pairing is known as the disposition effect, which is driven by loss aversion.
- Aloss aversionCorrect
- Bmental accounting
- Cconservatism bias
Explanation
Loss aversion makes realizing a loss feel more painful than an equivalent gain feels pleasurable, so the investor holds losers (waiting to break even) and sells winners early (the disposition effect). Mental accounting concerns separating money into categories, and conservatism bias concerns slow updating of beliefs; neither explains the pattern as directly.
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