Fat Tails and Stop-Losses in Portable Alpha

Journal of Investment Management (JOIM), Third Quarter 2011

Posted: 24 Aug 2011

See all articles by Mark B. Wise

Mark B. Wise

California Institute of Technology

Yonathan Schwarzkopf

Lime Brokerage LLC; Santa Fe Institute

Vineer Bhansali

LongTail Alpha, LLC

Date Written: August, 24 2011

Abstract

We investigate the optimal stop-loss on the alpha investment for a portable alpha vehicle. The optimal stop-loss maximizes investors utility of wealth for a portfolio consisting of a portable alpha fund and risk-free assets. We model the dynamics of the assets as a combination of a normal era with positive average returns and stressed era with negative average returns. We discuss the dependence of the optimal choice of stop-loss on the probability of being in the stressed era, the average return of the alpha asset in the stressed era and on the cost to liquidate the risky alpha asset.

Keywords: Portable alpha, stop-loss, regime shifts, utility, risk aversion, Sharpe ratio

JEL Classification: G00

Suggested Citation

Wise, Mark B. and Schwarzkopf, Yonathan and Bhansali, Vineer, Fat Tails and Stop-Losses in Portable Alpha (August, 24 2011). Journal of Investment Management (JOIM), Third Quarter 2011. Available at SSRN: https://ssrn.com/abstract=1916173

Mark B. Wise (Contact Author)

California Institute of Technology ( email )

Pasadena, CA 91125
United States
626-395-6687 (Phone)
626-568-8473 (Fax)

Yonathan Schwarzkopf

Lime Brokerage LLC ( email )

625 Broadway
New York, NY 10012
United States

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

Vineer Bhansali

LongTail Alpha, LLC ( email )

500 Newport Center Drive
Suite 820
Newport Beach, CA 92660
United States

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