Ellsberg Paradox and Disposition Effect
How the Price Change Can Affect Investment Decisions to Realize Gain or Loss.
DOI:
https://doi.org/10.25120/jre.5.1.2025.4215Keywords:
Disposition Effect, Ellsberg Paradox, Ambiguity, Asset Liquidation, Logistic RegressionAbstract
The Ellsberg paradox can help us understand how ambiguity can induce asset liquidation, which is reflected by gain or loss realization in the disposition effect. This study investigates the impact of ambiguity (as the Ellsberg Paradox describes) and framing effects on the disposition effect in asset liquidation decisions. By integrating prospect theory with behavioral finance principles, the research seeks to understand how ambiguity connected with emotional biases influences investors' likelihood to liquidate assets under varying conditions of risk and uncertainty. The study uses logistic regression models to analyze data collected from a disposition effect simulation, examining their asset liquidation behaviors concerning the ambiguity and framing effects. The research incorporates subjective targets and tolerances to provide a nuanced understanding of the rationality of asset liquidation decisions in the gain and loss domain. The results indicate that higher ambiguity is associated with a lower probability of asset liquidation, particularly for gains, which aligns with the predictions of the Ellsberg Paradox. The study also finds that the framing effect serves as a quasi-moderator, enhancing investors' decision-making by aligning their actions with personal targets and tolerances. These findings confirm the presence of the disposition effect, with investors more likely to realize gains than losses, but this behavior is moderated by ambiguity and framing considerations. The study offers valuable insights for financial advisors, portfolio managers, and policymakers by highlighting the importance of managing ambiguity and framing in investment strategies. It suggests using decision aids and educational interventions to help investors make more rational decisions, thereby mitigating the negative impacts of behavioral biases. This paper uses logistic regression to unveil the interaction between asset liquidation, ambiguity, and the framing effect in investment decisions. Separate models explain gain and loss realization to understand better how ambiguity differs in winning and losing assets. Furthermore, the additional context of target and tolerance is added to the models, which can prove not all gain realization is irrational based on the bounded rationality of the decision-makers.
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