Test of Endowment and Disposition Effects under Prospect Theory on Decision-Making Process of Individual Investors at the Nairobi Securities Exchange, Kenya

Abstract

This study examined investment simulations on investors in the Nairobi Securities Exchange by adopting the Prospect Theory developed by Kahneman and Tversky in 1979. It revealed that the process of investment decision making deviates from standard finance principles and is based on “Behavioral Economics Theory”. The study tested and identified two effects namely: the endowment effect or the tendency to become attached to assets even when better investment opportunities emerge and the disposition effect that is the tendency to sell assets that have gained value (winners) and keep assets that have lost value (losers). The study concluded that both endowment and disposition effects influenced the decisions made by individual investors. The gender, length of trading in the stock market and consulting financial investment advisors had no effect on endowment effect. Further, the study concluded that endowment effect is motivated by a higher regret of commission than regret of omission by investors.

Key words: behavioral finance, market efficiency, prospect theory, investor psychology, Nairobi Securities Exchange, Kenya