Speculative trading, prospect theory and transaction costs

DOI10.1007/S00780-022-00494-7zbMATH Open1505.91373arXiv1911.10106OpenAlexW2991462544MaRDI QIDQ2111243FDOQ2111243

Authors: Alex S. L. Tse, Harry Zheng 

Publication date: 28 December 2022

Published in: Finance and Stochastics (Search for Journal in Brave)

Abstract: A speculative agent with Prospect Theory preference chooses the optimal time to purchase and then to sell an indivisible risky asset to maximize the expected utility of the round-trip profit net of transaction costs. The optimization problem is formulated as a sequential optimal stopping problem and we provide a complete characterization of the solution. Depending on the preference and market parameters, the optimal strategy can be "buy and hold", "buy low sell high", "buy high sell higher" or "no trading". Behavioral preference and market friction interact in a subtle way which yields surprising implications on the agent's trading patterns. For example, increasing the market entry fee does not necessarily curb speculative trading, but instead it may induce a higher reference point under which the agent becomes more risk-seeking and in turn is more likely to trade.

Full work available at URL: https://arxiv.org/abs/1911.10106

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zbMATH Keywords

transaction costsS-shaped utilityentry-and-exit strategiessequential optimal stopping

Mathematics Subject Classification ID

Financial markets (91G15) Utility theory (91B16) Stopping times; optimal stopping problems; gambling theory (60G40)

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Cited In (5)

• Title not available (Why is that?)
• Speculative trading in mean reverting markets
• From hedging to speculation -- an explanation based on prospect theory
• Common beliefs and the existence of speculative trade
• Title not available (Why is that?)

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