Dynamic Trading with Reference Point Adaptation and Loss Aversion

Yun Shi; Xiangyu Cui; Jing Yao; Duan Li

doi:10.1287/opre.2015.1399

Dynamic Trading with Reference Point Adaptation and Loss Aversion

Yun Shi¹; Xiangyu Cui²; Jing Yao³; Duan Li⁴

¹ School of Management, Shanghai University, Shanghai, China · ² School of Statistics and Management, Shanghai University of Finance and Economics, Shanghai, China · ³ Institute for Financial Studies, School of Economics, Fudan University, Shanghai, China · ⁴ Department of Systems Engineering and Engineering Management, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong

Operations Research 2015

We formalize the reference point adaptation process by relating it to a way people perceive prior gains and losses. We then develop a dynamic trading model with reference point adaptation and loss aversion, and derive its semi-analytical solution. The derived optimal stock holding has an asymmetric V-shaped form with respect to prior outcomes, and the related sensitivities are directly determined by the sensitivities of reference point shifts with respect to the outcomes. We also find that the effects of reference point adaptation can be used to shed light on some well documented trading patterns, e.g., house money, break even, and disposition effects.

DOI: 10.1287/opre.2015.1399
Volume: 63 (4)
Pages: 789-806
Language: en
Export: BibTeX
Sources: crossref