Stop-Loss Strategies with Serial Correlation, Regime Switching, and Transactions Costs
52 Pages Posted: 27 Nov 2015
Date Written: November 23, 2015
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: Suggested Citation