Stop-loss Strategy Research Articles

Wolf in Sheep's Clothing: The Active Investment Strategies Behind Index Performance

This paper argues that the commonly used market indices imply forms of active investment management in disguise. The selection and rebalancing rules make these indices highly exclusive and dynamic regarding their underlying components and significantly bias their performance. Any passive investment tracking these indices turns into an active strategy characterised by market timing and state-dependent performance. Evidence is provided that exclusive indices outperform (underperform) more inclusive peer indices over upward (downward) markets. The constitution and maintenance rules of exclusive indices correspond to a set of active trading and investment rules similar to momentum and stop-loss strategies.

A new class of nearly self-financing strategies

For a large class of models, we prove that the stop-loss start-gain trading strategy is as close to producing arbitrage as we please.

On stop-loss strategies for stock investments

This paper studies the expected return of a stock investment with a stop-loss strategy. The probability density function (p.d.f.) for the investment value is formulated as the solution for a boundary value problem of a partial differential equation (PDE). Then, the expected value is manipulated as a function of the stop-loss probability. Two examples are solved by an analytic method. Finally, we design a boundary element method (BEM) to solve the boundary value problem for a general stop-loss criterion.

On the Profit and Loss Distribution of Dynamic Hedging Strategies

Hedging a derivative security with non-risk-neutral number of shares leads to portfolio profit or loss. Unlike in the Black-Scholes world, the net present value of all future cash flows till maturity is no longer deterministic, and basis risk may be present at any time. The key object of our analysis is probability distribution of future P&L conditioned on the present value of the underlying. We consider time dynamics of this probability distribution for an arbitrary hedging strategy. We assume log-normal process for the value of the underlying asset and use convolution formula to relate conditional probability distribution of P&L at any two successive time moments. It leads to a simple PDE on the probability measure parameterized by a hedging strategy. For risk-neutral replication the P&L probability distribution collapses to a delta-function at the Black-Scholes price of the contingent claim. Therefore, our approach is consistent with the Black-Scholes one and can be viewed as its generalization. We further analyze the PDE and derive formulae for hedging strategies targeting various objectives, such as minimizing variance or optimizing distribution quantiles. The developed method of computing the profit and loss distribution for a given hedging scheme is applied to the classical example of hedging a European call option using the stop-loss strategy. This strategy refers to holding 1 or 0 shares of the underlying security depending on the market value of such security. It is shown that the stop-loss strategy can lead to a loss even for an infinite frequency of re-balancing. The analytical method allows one to compute profit and loss distributions without relying on simulations. To demonstrate the strength of the method we reproduce the Monte Carlo results on stop-loss strategy given in Hull's book, and improve the precision beyond the limits of regular Monte-Carlo simulations.

Nonfundamental FX trading and excess volatility in credible target zones Theory and empirical evidence

This paper presents a target zone model with imperfect asset substitutability in which exchange rates are driven both by expectations regarding the credible defense of the currency band and foreign exchange traders' stop-loss trading strategies. The model generates excess volatility and nonuniqueness in the density function of the exchange rate. These results obtain independently of whether the stop-loss strategies are known to the market. In an empirical section, the authors find support for the existence of excess volatility for selected countries of the European monetary system (EMS) during the stable EMS period.

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

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 result 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 percent in equity as long as the value of the portfolio exceeds a lower limit where the investor switches to 100 percent 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 strategy is optimal for investors with a nondifferentiable utility function.

Theory of constant proportion portfolio insurance

We study constant proportion portfolio insurance (CPPI), a dynamic strategy that maintains the portfolio's risk exposure a constant multiple of the excess of wealth over a floor, up to a borrowing limit. We use this simple rule to investigate how transaction costs and borrowing constraints affect portfolio insurance-type strategies. Absent transaction costs, CPPI is equivalent to investing in perpetual American call options, and is optimal for a piecewise-HARA utility function with a minimum consumption constraint. As the multiple increases, the payoffs under CPPI approach those of a stop-loss strategy. The expected holding-period return is not monotonic in the multiple, and a higher expected return can be obtained under CPPI than with a stop-loss strategy.

Gambler's ruin and optimal stop loss strategy

Journal of Futures MarketsVolume 9, Issue 6 p. 565-571 Article Gambler's ruin and optimal stop loss strategy Gang Shyy, Gang Shyy Director of Research for Bridgewater Associates, Inc., Wilton, ConnecticutSearch for more papers by this author Gang Shyy, Gang Shyy Director of Research for Bridgewater Associates, Inc., Wilton, ConnecticutSearch for more papers by this author First published: December 1989 https://doi.org/10.1002/fut.3990090609Citations: 4 AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Citing Literature Volume9, Issue6December 1989Pages 565-571 RelatedInformation