Optimal Short-Covering with Regime Switching*

Tsz-Kin Chung

Chapter 4 in Recent Advances in Financial Engineering 2014:Proceedings of the TMU Finance Workshop 2014, 2016, pp 75-93 from World Scientific Publishing Co. Pte. Ltd.

Abstract: We formulate a short-selling strategy of a stock and seek the optimal timing of short covering in the presence of a random recall and a loan fee rate in an illiquid stock loan market. The aim is to study how the optimal trading strategy of the short-seller is influenced by the relevant features of the stock loan market. We consider a regime-switching stock price model that captures the transition in between the bull and the bear markets. The solution to the optimal stopping problem is obtained in closed-form based on the techniques in Guo and Zhang (2005). We provide the numerical example to illustrate of importance of a regime-dependent stopping rule for the short-seller's problem.

Keywords: Financial Engineering; Mathematical Finance; Money & Banking; Risk Management; Real Option; Corporate Finance; Computational Finance (search for similar items in EconPapers)
Date: 2016
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