How Does Learning and Education Help to Overcome the Disposition Effect?

How Does Learning and Education Help to Overcome the Disposition Effect?

Tarvo Vaarmets, Kristjan Liivamägi, Tõnn Talpsepp
Review of Finance, Volume 23, Issue 4, July 2019, Pages 801–830,

The ability of investors to learn from their own mistakes is an important factor that can help prevent them taking short-sighted or biased investment decisions. The disposition effect is a bias that is still prevalent in the financial markets and means that investors tend to hold on to underwater positions for too long and to give up winning positions too early.

Our contribution to the literature is to provide empirical insights into how education, intelligence, and certain mental abilities affect the disposition effect. We show that higher intelligence and stronger learning abilities as measured by education level and the type of education lessen the disposition effect. We also show that learning abilities and the speed of learning can vary greatly and affect the disposition effect, even though we do not identify any strong effects from “learning about one’s abilities.”

Our exhaustive NASDAQ Tallinn dataset allows us to measure intelligence and certain mental abilities in an educational setting before investors enter the stock market and to observe their subsequent behavior in the stock market. Moreover, the use of Estonian data provides a unique opportunity to work with a complete dataset which is not affected by subsample selection biases.

Employing survival analysis our results indicate that learning abilities are one of the most important components of intelligence in affecting the disposition effect. We find support for the hypothesis that “baseline learning abilities” play an important role in affecting the disposition effect. When we consider the components of overall intelligence, we find the strongest effect is for long-term learning abilities. Investors with higher academic degrees or more challenging academic paths, which can serve as an indication of higher intelligence, learn faster by doing and are also less influenced by the disposition effect. We also find that mathematical abilities are beneficial for overcoming the disposition effect.

If we generalize our results, intelligence tends to be an important reason why only a small proportion of investors are able to learn fast enough to eliminate the emergence of behavioural biases in the financial markets, as learning by doing is not very efficient. While domain knowledge can help investors learn a little faster when they enter the market, educating investors must be seen as a long process and it will be inevitable that some investors will just not be able to learn despite the efforts made.

Figure. The speed and magnitude of learning by doing for different education groups. The higher the hazard ratios, the less investors are influenced by the disposition effect given that they have made a particular number of trades.

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