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On the Inefficiency of Bang-Bang and Stop-Loss Portfolio Strategies


  • Gollier, Christian


We show in this article that bang-bang portfolio strategies where the investor is alternatively 100% in equity and 100% in cash are dynamically inefficient. Our proof of this is based on a simple second-order stochastic dominance (SSD) argument. It implies that this is true for any decision criterion that satisfies SSD, not necessarily expected utility. We also examine the stop-loss strategy in which the investor is 100% in equity as long as the value of the portfolio exceeds a lower limit where the investor switches to 100% in cash. Again, we show that this strategy is inefficient under second-order risk aversion. However, a slight modification of it--in which all wealth exceeding a minimum reserve is invested in equity--is shown to be an efficient dynamic portfolio strategy. This is optimal for investors with a nondifferentiable utility function. Copyright 1997 by Kluwer Academic Publishers

Suggested Citation

  • 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.
  • Handle: RePEc:kap:jrisku:v:14:y:1997:i:2:p:143-54

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    Cited by:

    1. Andrew Clare & James Seaton & Peter N Smith & Stephen Thomas, 2012. "BREAKING INTO THE BLACKBOX: Trend Following, Stop Losses, and the Frequency of Trading: the case of the S&P500," Discussion Papers 12/11, Department of Economics, University of York.
    2. Jakusch, Sven Thorsten & Meyer, Steffen & Hackethal, Andreas, 2016. "Taming models of prospect theory in the Wild? Estimation of Vlcek and Hens (2011)," SAFE Working Paper Series 146, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.

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