ABSTRACT A contrast effect occurs when the value of a previously observed signal inversely biases perception of the next signal. We present the first evidence that contrast effects can distort prices in sophisticated and liquid markets. Investors mistakenly perceive earnings news today as more impressive if yesterday's earnings surprise was bad and less impressive if yesterday's surprise was good. A unique advantage of our financial setting is that we can identify contrast effects as an error in perceptions rather than expectations. Finally, we show that our results cannot be explained by an alternative explanation involving information transmission from previous earnings announcements.

A contrast effect occurs when the value of a previously observed signal inversely biases perception of the next signal. We present the first evidence that contrast effects can distort prices in sophisticated and liquid markets. Investors mistakenly perceive earnings news today as more impressive if yesterday's earnings surprise was bad and less impressive if yesterday's surprise was good. A unique advantage of our financial setting is that we can identify contrast effects as an error in perceptions rather than expectations. Finally, we show that our results cannot be explained by an alternative explanation involving information transmission from previous earnings announcements.

When investors sell one asset and quickly buy another (“reinvestment days”), their trades suggest the original mental account is not closed, but is instead rolled into the new asset. Retail investors trading on their own accounts display a rolled disposition effect, selling the new position when its value exceeds the initial investment in the original position. On reinvestment days, these investors display no disposition effect (consistent with no disutility from realizing a loss) and make better selling decisions. Using a laboratory experiment, we show that reinvestment causally reduces the disposition effect and improves trading.

When investors sell one asset and quickly buy another (“reinvestment days”), their trades suggest the original mental account is not closed, but is instead rolled into the new asset. Retail investors trading on their own accounts display a rolled disposition effect, selling the new position when its value exceeds the initial investment in the original position. On reinvestment days, these investors display no disposition effect (consistent with no disutility from realizing a loss) and make better selling decisions. Using a laboratory experiment, we show that reinvestment causally reduces the disposition effect and improves trading. Received April 10, 2016; editorial decision January 28, 2017 by Editor Andrew Karolyi.