## Journal of Applied Probability

- J. Appl. Probab.
- Volume 50, Number 2 (2013), 374-387.

### Optimal closing of a momentum trade

Erik Ekström and Carl Lindberg

#### Abstract

There is an extensive academic literature that documents that stocks which have performed well in the past often continue to perform well over some holding period - so-called momentum. We study the optimal timing for an asset sale for an agent with a long position in a momentum trade. The asset price is modelled as a geometric Brownian motion with a drift that initially exceeds the discount rate, but with the opposite relation after an unobservable and exponentially distributed time. The problem of optimal selling of the asset is then formulated as an optimal stopping problem under incomplete information. Based on the observations of the asset, the agent wants to detect the unobservable change point as accurately as possible. Using filtering techniques and stochastic analysis, we reduce the problem to a one-dimensional optimal stopping problem, which we solve explicitly. We also show that the optimal boundary at which the investor should liquidate the trade depends monotonically on the model parameters.

#### Article information

**Source**

J. Appl. Probab., Volume 50, Number 2 (2013), 374-387.

**Dates**

First available in Project Euclid: 19 June 2013

**Permanent link to this document**

https://projecteuclid.org/euclid.jap/1371648947

**Digital Object Identifier**

doi:10.1239/jap/1371648947

**Mathematical Reviews number (MathSciNet)**

MR3102486

**Zentralblatt MATH identifier**

1266.91095

**Subjects**

Primary: 91G10: Portfolio theory

Secondary: 60G40: Stopping times; optimal stopping problems; gambling theory [See also 62L15, 91A60]

**Keywords**

Optimal stopping momentum trading quickest detection problem for Brownian motion

#### Citation

Ekström, Erik; Lindberg, Carl. Optimal closing of a momentum trade. J. Appl. Probab. 50 (2013), no. 2, 374--387. doi:10.1239/jap/1371648947. https://projecteuclid.org/euclid.jap/1371648947