The impact of the disposition effect on asset prices: insight from the NBA

In this paper we examine the price movements of contracts that represent bets on NBA games and find that the disposition effect causes significant deviations between contract prices and values. The contracts under examination are listed on Tradesports, a prediction market which provides an ideal venue for testing this and other behavioral theories because of its asset properties, market structure, and the absence of the joint hypothesis problem. In our analysis, we forecast the projected final combined scores of both teams in a contest based on observed within-game scores and game time remaining. At all points in time throughout each game, mean future returns (measured as Ticks to Expiry) should be no different than zero. However, we find that contracts which have fallen off pace to exceed the stated contract total become overpriced and experience negative future returns. Likewise, we provide evidence that contracts on games in which teams are on pace to exceed the stated total become underpriced and experience significantly positive future returns. These findings are consistent with the disposition effect in which traders tend to hold losing positions to avoid realizing losses yet prematurely unwind winning positions to realize gains.