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Partial liquidation under reference-dependent preferences

Vicky Henderson () and Jonathan Muscat ()
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Vicky Henderson: University of Warwick
Jonathan Muscat: University of Warwick

Finance and Stochastics, 2020, vol. 24, issue 2, 335-357

Abstract: Abstract We propose a multiple optimal stopping model where an investor can sell a divisible asset position at times of her choosing. Investors have S$S$-shaped reference-dependent preferences, whereby utility is defined over gains and losses relative to a reference level and is concave over gains and convex over losses. For a price process following a time-homogeneous diffusion, we employ the constructive potential-theoretic solution method developed by Dayanik and Karatzas (Stoch. Process. Appl. 107:173–212, 2003). As an example, we revisit the single optimal stopping model of Kyle et al. (J. Econ. Theory 129:273–288, 2006) to allow partial liquidation. In contrast to the extant literature, we find that the investor may partially liquidate the asset at distinct price thresholds above the reference level. Under other parameter combinations, the investor sells the asset in a block, either at or above the reference level.

Keywords: Multiple optimal stopping; Reference-dependent preferences; Prospect theory; Behavioural finance; 60G40; 60J60 (search for similar items in EconPapers)
JEL-codes: D81 G40 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s00780-020-00421-8

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