'Stop-Loss' Strategies: Theory and Application to the Matif Bond Future Contract (In French)

Abstract

To explain the existence of stop-loss rules in financial institutions, we develop a principal/agent model, where an investment firm (the principal) has to rely on the expertise of a trader (the agent) to invest in a risky asset (a future contract, say). When the trader faces a limited liability constraint, we show that the investment firm may increase its gains by committing to enforce stop-loss rules i. e. to liquidate the asset when the return is low. Using daily data on individual positions in the French Treasury bond future market, we find evidence in favor of one testable implication of the model, namely that positions are more likely to be sold off when realized profits are very negative. More than 20% of individual accounts seem to use stop-loss strategies in our database (the English version of the paper is available upon request from the authors).