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Dynamic Trading with Reference Point Adaptation and Loss Aversion

Author

Listed:
  • Yun Shi

    () (School of Management, Shanghai University, Shanghai, China)

  • Xiangyu Cui

    () (School of Statistics and Management, Shanghai University of Finance and Economics, Shanghai, China)

  • Jing Yao

    () (Institute for Financial Studies, School of Economics, Fudan University, Shanghai, China)

  • Duan Li

    () (Department of Systems Engineering and Engineering Management, The Chinese University of Hong Kong, Shatin N. T., Hong Kong)

Abstract

We formalize the reference point adaptation process by relating it to a way people perceive prior gains and losses. We then develop a dynamic trading model with reference point adaptation and loss aversion, and derive its semi-analytical solution. The derived optimal stock holding has an asymmetric V-shaped form with respect to prior outcomes, and the related sensitivities are directly determined by the sensitivities of reference point shifts with respect to the outcomes. We also find that the effects of reference point adaptation can be used to shed light on some well documented trading patterns, e.g., house money, break even, and disposition effects.

Suggested Citation

  • Yun Shi & Xiangyu Cui & Jing Yao & Duan Li, 2015. "Dynamic Trading with Reference Point Adaptation and Loss Aversion," Operations Research, INFORMS, vol. 63(4), pages 789-806, August.
  • Handle: RePEc:inm:oropre:v:63:y:2015:i:4:p:789-806
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    File URL: http://dx.doi.org/10.1287/opre.2015.1399
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    References listed on IDEAS

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    3. repec:wsi:ijtafx:v:21:y:2018:i:07:n:s0219024918500425 is not listed on IDEAS
    4. Guo, Jing & He, Xue Dong, 2017. "Equilibrium asset pricing with Epstein-Zin and loss-averse investors," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 86-108.
    5. repec:pal:jorsoc:v:68:y:2017:i:12:d:10.1057_s41274-017-0179-6 is not listed on IDEAS

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