Reference point formation by market investors

Doron Kliger, Andrey Kudryavtsev

Research output: Contribution to journalArticlepeer-review


The disposition effect [Shefrin, H., Statman M., 1985, The disposition to sell winners too early and ride losers too long. Journal of Finance, 40, 777-790], investors' tendency to sell gaining assets and hold on to loosing assets, relies on the notion of a reference point distinguishing between losses and gains. While literature using aggregated market data documented the existence of such a reference point affecting investors' decisions, it had not pinpointed it. The main goal of our work is to shed light on the mechanism of reference point formation. We hypothesize that salient events taking place during a stock's holding period influence investors' perceptions and make them update the stock's reference point. Using analysts' earnings forecasts, stock price data, and firms' quarterly earnings announcements, we document that company-specific events indeed affect the reference points. We discover that the earnings announcements played a role in reference point formation when they were not anticipated, i.e., when (i) analysts' earnings forecasts failed to provide accurate predictions; and (ii) the earnings announcements were followed by market price reactions. Moreover, the reference points were affected more profoundly for low market capitalization, high beta firms, pointing that the reference point updating process is more reactive to events when information flow is low and prices are sensitive to market fluctuations. Our results also corroborate the attention hypothesis, i.e., the observation that agents facing numerous alternatives may consider primarily those that have caught their attention.

Original languageEnglish
Pages (from-to)1782-1794
Number of pages13
JournalJournal of Banking and Finance
Issue number9
StatePublished - Sep 2008

Bibliographical note

Funding Information:
This paper was reviewed and accepted while Prof. Giorgio Szego was the Managing Editor of The Journal of Banking and Finance and by the past Editorial Board. We thank participants of the IAREP – SABE Joint Meeting in Paris, 2006. The financial support of the Zimmerman Foundation for the study of Banking and Finance at the University of Haifa is gratefully acknowledged. We wish to thank Giorgio Szego (the Editor) and an annonimous referee for their insightful remarks. The research assistance of Yaron Yosseph and Liron Sin-Shmuel is greatly acknowledged.


  • Behavioral finance
  • Disposition effect
  • Mental accounting
  • Prospect theory
  • Reference point

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics


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