Offsetting the disposition effect with a stop-loss rule

Elder Mauricio Silva, Sergio Da Silva

Abstract


We put forward an agent-based model of the stock market, where the behavior of agents showing the disposition effect can be offset by that of others using a stop-loss rule. In a stop-loss order, a stock is sold automatically if it drops below a threshold value. The disposition effect is the tendency to sell stocks that have gained in value (“winners”) and keep the ones that have fallen in value (“losers”). After showing the model can replicate actual return behavior considering data from the recent mini flash crashes, we explore the consequences of altering key behavioral parameters. Our primary result is that the presence of stop-loss agents in a non-Gaussian environment can offset the disposition effect. Furthermore, we find differing return targets to contribute to market efficiency, and a negative shock to a market sentiment index to cause the stock price to dip and trade volume to grow. Finally, increasing overconfidence generates higher trade volume.

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Published: 2015-03-17

How to Cite this Article:

Elder Mauricio Silva, Sergio Da Silva, Offsetting the disposition effect with a stop-loss rule, Math. Finance Lett., 2015 (2015), Article ID 2

Copyright © 2015 Elder Mauricio Silva, Sergio Da Silva. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Mathematical Finance Letters

ISSN 2051-2929

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