Selling a stock at the ultimate maximum

DOI10.1214/08-AAP566zbMATH Open1201.60037arXiv0908.1014MaRDI QIDQ2389600FDOQ2389600

Authors: Jacques Du Toit, Goran Peskir 

Publication date: 17 July 2009

Published in: The Annals of Applied Probability (Search for Journal in Brave)

Abstract: Assuming that the stock price $Z=(Z_t{)}_{0leqtleqT}$ follows a geometric Brownian motion with drift $muinmathbbR$ and volatility $sigma>0$, and letting $M_t=ma{x}_{0leqsleqt}{Z}_s$ for $tin[0,T]$, we consider the optimal prediction problems [V_1=inf_{0leq auleq T}mathsf{E}�iggl(frac{M_T}{Z_{ au}}�iggr)quadandquad V_2=sup_{0leq auleq T}mathsf{E}�iggl(frac{Z_{ au}}{M_T}�iggr),] where the infimum and supremum are taken over all stopping times $au$ of $Z$. We show that the following strategy is optimal in the first problem: if $muleq0$ stop immediately; if $muin(0,sigm{a}^2)$ stop as soon as $M_t/Z_t$ hits a specified function of time; and if $mugeqsigm{a}^2$ wait until the final time $T$. By contrast we show that the following strategy is optimal in the second problem: if $muleqsigm{a}^2/2$ stop immediately, and if $mu>sigm{a}^2/2$ wait until the final time $T$. Both solutions support and reinforce the widely held financial view that ``one should sell bad stocks and keep good ones. The method of proof makes use of parabolic free-boundary problems and local time--space calculus techniques. The resulting inequalities are unusual and interesting in their own right as they involve the future and as such have a predictive element.

Full work available at URL: https://arxiv.org/abs/0908.1014

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zbMATH Keywords

geometric Brownian motionoptimal stoppingsmooth fitultimate maximum

Mathematics Subject Classification ID

Brownian motion (60J65) Stopping times; optimal stopping problems; gambling theory (60G40) Optimal stopping in statistics (62L15) Financial applications of other theories (91G80)

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