Stop-Loss Strategies with Serial Correlation, Regime Switching, and Transactions Costs

52 Pages Posted: 27 Nov 2015

See all articles by Andrew W. Lo

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering; Santa Fe Institute

Alexander Remorov

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: November 23, 2015

Abstract

Stop-loss strategies are commonly used by investors to reduce their holdings in risky assets if prices or total wealth breach certain pre-specified thresholds. We derive closed-form expressions for the impact of stop-loss strategies on asset returns that are serially correlated, regime switching, and subject to transactions costs. When applied to a large sample of individual U.S. stocks, we show that tight stop-loss strategies tend to underperform the buy-and-hold policy in a mean-variance framework due to excessive trading costs. Outperformance is possible for stocks with sufficiently high serial correlation in returns. Certain strategies succeed at reducing downside risk, but not substantially.

Keywords: Stop-Loss Strategy, Portfolio Insurance, Risk Management, Investments, Portfolio Management, Asset Allocation, Performance Attribution, Behavioral Finance

JEL Classification: G11, G12

Suggested Citation

Lo, Andrew W. and Remorov, Alexander, Stop-Loss Strategies with Serial Correlation, Regime Switching, and Transactions Costs (November 23, 2015). Available at SSRN: https://ssrn.com/abstract=2695383 or http://dx.doi.org/10.2139/ssrn.2695383

Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

Alexander Remorov

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~alexrem/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
1,003
Abstract Views
3,774
rank
32,038
PlumX Metrics