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

52 Pages Posted: 27 Nov 2015  

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

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) - Sloan School of Management ( email )

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

National Bureau of Economic Research (NBER) ( email )

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Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
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/

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