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Realization utility with stop-loss strategy

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  • 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
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    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

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