Journal of Applied Probability
- J. Appl. Probab.
- Volume 50, Number 2 (2013), 374-387.
Optimal closing of a momentum trade
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.
J. Appl. Probab., Volume 50, Number 2 (2013), 374-387.
First available in Project Euclid: 19 June 2013
Permanent link to this document
Digital Object Identifier
Mathematical Reviews number (MathSciNet)
Zentralblatt MATH identifier
Primary: 91G10: Portfolio theory
Secondary: 60G40: Stopping times; optimal stopping problems; gambling theory [See also 62L15, 91A60]
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