Topic: Financing Constraints and the Disposition Effect
Speaker: Mitch Warachka, Associate Professor of Finance, Claremont McKenna College
Date: March 19th, 2014 (Wed.)
Time: 1:00-2:30pm
Location: Building 4, Room 101
Language: English
Abstract:
The disposition effect predicts that assets with capital gains are more likely to be sold than similar assets with capital losses. By relying on either realization utility preferences, cognitive dissonance, or an irrational belief in mean reversion, explanations for the disposition effect are usually behavioral. Our paper examines an alternative explanation for the disposition effect-financing constraints. Using a unique and comprehensive set of real estate transactions in Singapore, we report that buyer financing constraints explain at least half of the disposition effect's appearance. This evidence is consistent with Stein (1995)'s model that has capital gains alleviating the financing constraints of repeat buyers. Singapore's real estate market is ideally suited for testing hypotheses related to the disposition effect due to its liquidity. Indeed, the residential property market in Singapore consists of standardized units within a larger development that are financed using standardized mortgage contracts. This homogeneity enables unit-level capital gains, down-payments, and principal repayments to be estimated accurately. As predicted by tighter financing constraints, larger government-mandated down-payments for buyers strengthen the appearance of the disposition effect. We also construct a unit-level measure of homeowner equity by aggregating down-payments with cumulative principal repayments and capital gains to capture a property owner's ability to finance another purchase by selling their existing unit. This equity measures explain more variation in unit-level sell propensities than capital gains, especially for households that are more likely to be financially constrained. We conclude that the appearance of the disposition effect can arise in markets where transactions are financed with leverage.
About the speaker:
Dr. Mitch Warachka is an Associate Professor of Finance at Claremont McKenna College. Dr. Warachka received his Ph.D. in Finance from Johnson Graduate School of Management at Cornell University in 2000 and his M.B.A. from University of Chicago in 1996. Dr. Warachka’s current research interests focus on asset pricing, corporate governance and derivatives. His research has been published in several leading academic journals, such as Journal of Financial Economics, Review of Financial Studies, Journal of Banking & Finance and Management Science. Dr. Warachka has teaching experience in Global Finance, Derivatives, and Fixed Income at Claremont McKenna College.
