IDEAS home Printed from https://ideas.repec.org/a/eee/quaeco/v81y2021icp261-275.html
   My bibliography  Save this article

Realization utility with stop-loss strategy

Author

Listed:
  • Yang, Chunpeng
  • Zhang, Zhanpei

Abstract

We present a realization utility model with a stop-loss strategy, in which the investor will sell his position and leave the market instantly when the asset price drops to a certain preset level. The model gives the analytical solutions to the value function and the optimal liquidation point. We show that the stop-loss strategy will increase the value function and specifically the growth will be larger when the asset price is close to the stop-loss level, and smaller when the price is relatively high above from it. In addition, we show that the stop-loss strategy will decease the optimal liquidation point, which means it will induce the investor to voluntarily liquidate earlier at a lower take-profit level. Our results highlight the contribution of the stop-loss strategy to utility maximum, which could shed light on the value of this kind of strategies.

Suggested Citation

  • Yang, Chunpeng & Zhang, Zhanpei, 2021. "Realization utility with stop-loss strategy," The Quarterly Review of Economics and Finance, Elsevier, vol. 81(C), pages 261-275.
    • Handle: RePEc:eee:quaeco:v:81:y:2021:i:c:p:261-275
    DOI: 10.1016/j.qref.2021.06.017
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1062976921001174
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.qref.2021.06.017?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Muhl, Stefan & Talpsepp, Tõnn, 2018. "Faster learning in troubled times: How market conditions affect the disposition effect," The Quarterly Review of Economics and Finance, Elsevier, vol. 68(C), pages 226-236.
    2. Gollier, Christian, 1997. "On the Inefficiency of Bang-Bang and Stop-Loss Portfolio Strategies," Journal of Risk and Uncertainty, Springer, vol. 14(2), pages 143-154, March.
    3. Annaert, Jan & Osselaer, Sofieke Van & Verstraete, Bert, 2009. "Performance evaluation of portfolio insurance strategies using stochastic dominance criteria," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 272-280, February.
    4. Philip H. Dybvig, 1988. "Inefficient Dynamic Portfolio Strategies or How to Throw Away a Million Dollars in the Stock Market," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 67-88.
    5. Urs Fischbacher & Gerson Hoffmann & Simeon Schudy, 2017. "The Causal Effect of Stop-Loss and Take-Gain Orders on the Disposition Effect," Review of Financial Studies, Society for Financial Studies, vol. 30(6), pages 2110-2129.
    6. Barberis, Nicholas & Xiong, Wei, 2012. "Realization utility," Journal of Financial Economics, Elsevier, vol. 104(2), pages 251-271.
    7. Locke, Peter R. & Mann, Steven C., 2005. "Professional trader discipline and trade disposition," Journal of Financial Economics, Elsevier, vol. 76(2), pages 401-444, May.
    8. Alex Imas, 2016. "The Realization Effect: Risk-Taking after Realized versus Paper Losses," American Economic Review, American Economic Association, vol. 106(8), pages 2086-2109, August.
    9. Kaminski, Kathryn M. & Lo, Andrew W., 2014. "When do stop-loss rules stop losses?," Journal of Financial Markets, Elsevier, vol. 18(C), pages 234-254.
    10. Jonathan E. Ingersoll & Lawrence J. Jin, 2013. "Realization Utility with Reference-Dependent Preferences," Review of Financial Studies, Society for Financial Studies, vol. 26(3), pages 723-767.
    11. Xuedong He & Linan Yang, 2019. "Realization utility with adaptive reference points," Mathematical Finance, Wiley Blackwell, vol. 29(2), pages 409-447, April.
    12. Daniel W. Richards & Janette Rutterford & Devendra Kodwani & Mark Fenton-O'Creevy, 2017. "Stock market investors' use of stop losses and the disposition effect," The European Journal of Finance, Taylor & Francis Journals, vol. 23(2), pages 130-152, January.
    13. Dichtl, Hubert & Drobetz, Wolfgang, 2011. "Portfolio insurance and prospect theory investors: Popularity and optimal design of capital protected financial products," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1683-1697, July.
    14. Juhani T. Linnainmaa, 2010. "Do Limit Orders Alter Inferences about Investor Performance and Behavior?," Journal of Finance, American Finance Association, vol. 65(4), pages 1473-1506, August.
    15. Tim Leung & Xin Li, 2015. "Optimal Mean Reversion Trading With Transaction Costs And Stop-Loss Exit," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(03), pages 1-31.
    16. Ingmar Nolte, 2012. "A detailed investigation of the disposition effect and individual trading behavior: a panel survival approach," The European Journal of Finance, Taylor & Francis Journals, vol. 18(10), pages 885-919, November.
    17. Bin, Liu, 2015. "A new risk measure and its application in portfolio optimization: The SPP–CVaR approach," Economic Modelling, Elsevier, vol. 51(C), pages 383-390.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Zhang, Yong & Lu, Xiaomeng & Xiao, Jing Jian, 2023. "Does financial education help to improve the return on stock investment? Evidence from China," Pacific-Basin Finance Journal, Elsevier, vol. 78(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Daniel W. Richards & Janette Rutterford & Devendra Kodwani & Mark Fenton-O'Creevy, 2017. "Stock market investors' use of stop losses and the disposition effect," The European Journal of Finance, Taylor & Francis Journals, vol. 23(2), pages 130-152, January.
    2. Li, Jianbiao & Niu, Xiaofei & Li, Dahui & Cao, Qian, 2018. "Using Non-Invasive Brain Stimulation to Test the Role of Self-Control in Investor Behavior," EconStor Preprints 177890, ZBW - Leibniz Information Centre for Economics.
    3. Lepone, Grace & Tian, Gary, 2020. "Usage of conditional orders and the disposition effect in the stock market," Pacific-Basin Finance Journal, Elsevier, vol. 61(C).
    4. Hermann, Daniel & Mußhoff, Oliver & Rau, Holger A., 2019. "The disposition effect when deciding on behalf of others," Journal of Economic Psychology, Elsevier, vol. 74(C).
    5. Urs Fischbacher & Gerson Hoffmann & Simeon Schudy, 2017. "The Causal Effect of Stop-Loss and Take-Gain Orders on the Disposition Effect," The Review of Financial Studies, Society for Financial Studies, vol. 30(6), pages 2110-2129.
    6. Pelster, Matthias & Hofmann, Annette, 2018. "About the fear of reputational loss: Social trading and the disposition effect," Journal of Banking & Finance, Elsevier, vol. 94(C), pages 75-88.
    7. Henderson, Vicky & Hobson, David & Tse, Alex S.L., 2018. "Probability weighting, stop-loss and the disposition effect," Journal of Economic Theory, Elsevier, vol. 178(C), pages 360-397.
    8. Andrew Clare & James Seaton & Peter N Smith & Stephen Thomas, 2013. "Breaking into the blackbox: Trend following, stop losses and the frequency of trading – The case of the S&P500," Journal of Asset Management, Palgrave Macmillan, vol. 14(3), pages 182-194, June.
    9. Karolis Liaudinskas, 2022. "Human vs. Machine: Disposition Effect among Algorithmic and Human Day Traders," Working Paper 2022/6, Norges Bank.
    10. Jin, Miao & Liu, Yu-Jane & Meng, Juanjuan, 2019. "Fat-finger event and risk-taking behavior," Journal of Empirical Finance, Elsevier, vol. 53(C), pages 126-143.
    11. Jakusch, Sven Thorsten & Meyer, Steffen & Hackethal, Andreas, 2019. "Taming models of prospect theory in the wild? Estimation of Vlcek and Hens (2011)," SAFE Working Paper Series 146, Leibniz Institute for Financial Research SAFE, revised 2019.
    12. Gemayel, Roland & Preda, Alex, 2018. "Does a scopic regime erode the disposition effect? Evidence from a social trading platform," Journal of Economic Behavior & Organization, Elsevier, vol. 154(C), pages 175-190.
    13. Zhang, Xiaotao & Wang, Ziqiao & Hao, Jing & Liu, Jiubiao, 2022. "Stock market entry timing and retail investors' disposition effect," International Review of Financial Analysis, Elsevier, vol. 82(C).
    14. Flepp, Raphael & Meier, Philippe & Franck, Egon, 2021. "The effect of paper outcomes versus realized outcomes on subsequent risk-taking: Field evidence from casino gambling," Organizational Behavior and Human Decision Processes, Elsevier, vol. 165(C), pages 45-55.
    15. Liêu, L.M. & Pelster, M., 2020. "Framing and the disposition effect in a scopic regime," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 175-185.
    16. Raquel M. Gaspar & Paulo M. Silva, 2019. "Investors’ Perspective on Portfolio InsuranceExpected Utility vs Prospect Theories," Working Papers REM 2019/92, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    17. Vicky Henderson & Jonathan Muscat, 2020. "Partial liquidation under reference-dependent preferences," Finance and Stochastics, Springer, vol. 24(2), pages 335-357, April.
    18. Marco Pleßner, 2017. "The disposition effect: a survey," Management Review Quarterly, Springer, vol. 67(1), pages 1-30, February.
    19. Dierick, Nicolas & Heyman, Dries & Inghelbrecht, Koen & Stieperaere, Hannes, 2019. "Financial attention and the disposition effect," Journal of Economic Behavior & Organization, Elsevier, vol. 163(C), pages 190-217.
    20. Talpsepp, Tõnn & Vaarmets, Tarvo, 2019. "The disposition effect, performance, stop loss orders and education," Journal of Behavioral and Experimental Finance, Elsevier, vol. 24(C).

    More about this item

    Keywords

    Realization utility; Stop-loss strategy; Value function; Risk management;
    All these keywords.

    JEL classification:

    • C41 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Duration Analysis; Optimal Timing Strategies
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:quaeco:v:81:y:2021:i:c:p:261-275. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620167 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.