The authors empirically test the impact of the disposition effect on the price adjustment on the ex-dividend day of common stocks listed on the NYSE and Amex during 2001–2008. They conclude that stocks with accrued gains have a greater ex-dividend day price drop ratio than stocks with accrued losses.
The authors study how the disposition effect, the tendency of investors to sell winners and hold on to losers, affects the ex-dividend day price drop ratio (PDR) of common stocks listed on the NYSE and Amex. They attribute the positive relationship between the PDR and capital gains to the disposition effect because active selling by holders of winning stocks will most likely accelerate the downward price adjustment on the ex-dividend day.
How Is This Research Useful to Practitioners?
Portfolio managers and research analysts believe that the disposition effect plays an important role in asset pricing. Understanding the impact of the disposition effect on the price adjustment on the ex-dividend day of common stocks can help in making investment decisions.
The authors formulate three hypotheses stating that excess supply of winning stocks, higher unrealized gains accrued on a stock, and accumulated unrealized gains as opposed to unrealized losses for a given stock result in a higher PDR on the ex-dividend day and vice versa.
They use the capital gains overhang as a proxy, as computed by Grinblatt and Han (Journal of Financial Economics 2005), to determine the market-wide gain or loss accrued on a particular stock. In the proxy, the time series of the stock’s past prices and the time series of its concurrent and forward turnover values are used to measure the accrued gain or loss just before the ex-dividend day. They conclude that the disposition effect accelerates the downward price adjustment of winning stocks and restrains the downward price adjustment of losing stocks on the ex-dividend day.
How Did the Authors Conduct This Research?
The authors gather the CRSP history of prices and dividends paid by common stocks listed on the NYSE and Amex from 1 February 2001 to 31 December 2008. The time period selected eliminates a possible tick size effect, bid–ask bounce effect, and tax effect.
They test their hypotheses that winning stocks accelerate and losing stocks decelerate the PDR on the ex-dividend day with capital gains overhang as a proxy for market return. PDR is defined as the stock price drop on the ex-dividend day divided by the dividend amount, and it is estimated by using standard event study methodology.
The authors conclude that stocks with a positive capital gains overhang have a higher PDR than stocks with a negative capital gains overhang on the ex-dividend day because the PDR is positively related to the level of the capital gains overhang. They rule out the possibility of impact from pressure exerted by ex-dividend day traders on the PDR on ex-dividend day.
The authors, through their study of the impact of the disposition effect on the PDR on ex-dividend day, add disposition effect as one of the factors that can explain cross-sectional variation of the ex-dividend day PDR. Their findings help extend the determinants of the ex-dividend day price dynamics.