Speculative trading, prospect theory and transaction costs

A speculative agent with prospect theory preference chooses the optimal time to purchase and then to sell an indivisible risky asset to maximise the expected utility of the round-trip profit net of transaction costs. The optimisation problem is formulated as a sequential optimal stopping problem, an...

Full description

Saved in:
Bibliographic Details
Published in:Finance and stochastics 2023, Vol.27 (1), p.49-96
Main Authors: Tse, Alex S. L., Zheng, Harry
Format: Article
Language:English
Subjects:
Costs
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Expected utility
Finance
Insurance
Management
Market entry
Mathematics
Mathematics and Statistics
Optimization
Preferences
Price levels
Probability Theory and Stochastic Processes
Profits
Prospect theory
Quantitative Finance
Statistics for Business
Trading
Transaction costs
Utility functions
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:A speculative agent with prospect theory preference chooses the optimal time to purchase and then to sell an indivisible risky asset to maximise the expected utility of the round-trip profit net of transaction costs. The optimisation problem is formulated as a sequential optimal stopping problem, and we provide a complete characterisation 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”. Behavioural 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 may induce a higher reference point under which the agent becomes more risk-seeking and in turn is more likely to trade.
ISSN:0949-2984
1432-1122
DOI:10.1007/s00780-022-00494-7