When to sell an asset amid anxiety about drawdowns

TL;DR

This paper models how risk-averse investors with varying anxiety about asset drawdowns decide optimal selling strategies, revealing that stop-loss and trailing stops can be optimal depending on individual risk profiles.

Contribution

It introduces a novel stochastic model incorporating investor anxiety and drawdowns into optimal stopping problems for asset sales, highlighting new strategic selling behaviors.

Findings

Stop-loss and trailing stops can be optimal selling strategies.

Investor anxiety influences the timing of asset sales.

The model differentiates between traditional risk aversion and anxiety-driven decision making.

Abstract

We consider risk averse investors with different levels of anxiety about asset price drawdowns. The latter is defined as the distance of the current price away from its best performance since inception. These drawdowns can increase either continuously or by jumps, and will contribute towards the investor's overall impatience when breaching the investor's private tolerance level. We investigate the unusual reactions of investors when aiming to sell an asset under such adverse market conditions. Mathematically, we study the optimal stopping of the utility of an asset sale with a random discounting that captures the investor's overall impatience. The random discounting is given by the cumulative amount of time spent by the drawdowns in an undesirable high region, fine tuned by the investor's personal tolerance and anxiety about drawdowns. We prove that in addition to the traditional take-profit sales, the real-life employed stop-loss orders and trailing stops may become part of the optimal selling strategy, depending on different personal characteristics. This paper thus provides insights on the effect of anxiety and its distinction with traditional risk aversion on decision making.