Publications
13 results found
Tse ASL, Zheng H, 2023, Portfolio selection, periodic evaluations and risk taking, Operations Research, Vol: 71, Pages: 2078-2091, ISSN: 0030-364X
We present a continuous-time portfolio selection problem faced by an agent with S-shaped preference who maximizes the utilities derived from the portfolio’s periodic performance over an infinite horizon. The periodic reward structure creates subtle incentive distortion. In some cases, local risk aversion is induced, which discourages the agent from risk taking in the extreme bad states of the world. In some other cases, eventual ruin of the portfolio is inevitable, and the agent underinvests in the good states of the world to manipulate the basis of subsequent performance evaluations. We outline several important elements of incentive design to contain the long-term portfolio risk.
Armstrong J, Brigo D, Tse A, 2023, The importance of dynamic risk constraints for limited liability operators, Annals of Operations Research, Pages: 1-38, ISSN: 0254-5330
Previous literature shows that prevalent risk measures such as value at risk or expected shortfall are ineffective to curb excessive risk-taking by a tail-risk-seeking trader with S-shaped utility function in the context of portfolio optimisation. However, these conclusions hold only when the constraints are static in the sense that the risk measure is just applied to the terminal portfolio value. In this paper, we consider a portfolio optimisation problem featuring S-shaped utility and a dynamic risk constraint which is imposed throughout the entire trading horizon. Provided that the risk control policy is sufficiently strict relative to the Sharpe ratio of the asset, the trader’s portfolio strategies and the resulting maximal expected utility can be effectively constrained by a dynamic risk measure. Finally, we argue that dynamic risk constraints might still be ineffective if the trader has access to a derivatives market.
Lambrecht BM, Tse ASL, 2023, Liquidation, Bailout, and Bail-In: Insolvency Resolution Mechanisms and Bank Lending, JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS, Vol: 58, Pages: 175-216, ISSN: 0022-1090
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Tse ASL, Zheng H, 2022, Speculative trading, prospect theory and transaction costs, Finance and Stochastics, Vol: 27, Pages: 49-96, ISSN: 0949-2984
A speculative agent with prospect theory preference chooses the optimal time to purchase and then to sell an indivisible risky asset to maximise the expected utility of the round-trip profit net of transaction costs. The optimisation problem is formulated as a sequential optimal stopping problem, and we provide a complete characterisation of the solution. Depending on the preference and market parameters, the optimal strategy can be “buy and hold”, “buy low, sell high”, “buy high, sell higher” or “no trading”. Behavioural preference and market friction interact in a subtle way which yields surprising implications on the agent’s trading patterns. For example, increasing the market entry fee does not necessarily curb speculative trading, but instead may induce a higher reference point under which the agent becomes more risk-seeking and in turn is more likely to trade.
Tse ASL, 2020, Dividend policy and capital structure of a defaultable firm, Mathematical Finance, Vol: 30, Pages: 961-994, ISSN: 0960-1627
Default risk significantly affects the corporate policies of a firm. We develop a model in which a limited liability entity subject to default at an exponential random time jointly sets its dividend policy and capital structure to maximize the expected lifetime utility from consumption of risk‐averse equity investors. We give a complete characterization of the solution to the singular stochastic control problem. The optimal policy involves paying dividends to keep the ratio of firm's equity value to investors' wealth below a critical threshold. Dividend payout acts as a precautionary channel to transfer wealth from the firm to investors for mitigation of losses in the event of default. Higher the default risk, more aggressively the firm leverages and pays dividends.
Hobson D, Tse ASL, Zhu Y, 2019, A multi-asset investment and consumption problem with transaction costs, Finance and Stochastics, Vol: 23, Pages: 641-676, ISSN: 0949-2984
In this article, we study a multi-asset version of the Merton investment and consumption problem with CRRA utility and proportional transaction costs. We specialise to a case where transaction costs are zero except for sales and purchases of a single asset which we call the illiquid asset. We show that the underlying HJB equation can be transformed into a boundary value problem for a first order differential equation. Important properties of the multi-asset problem (including when the problem is well-posed, ill-posed, or well-posed for some values of transaction costs only) can be inferred from the behaviours of a quadratic function of a single variable and another algebraic function.
Hobson D, Tse ASL, Zhu Y, 2019, Optimal consumption and investment under transaction costs, Mathematical Finance, Vol: 29, Pages: 483-506, ISSN: 0960-1627
In this paper, we consider the Merton problem in a market with a single risky asset and proportional transaction costs. We give a complete solution of the problem up to the solution of a first-crossing problem for a first-order differential equation. We find that the characteristics of the solution (e.g., well-posedness) can be related to some simple properties of a univariate quadratic whose coefficients are functions of the parameters of the problem. Our solution to the problem via the value function includes expressions for the boundaries of the no-transaction wedge. Using these expressions, we prove a precise condition for when leverage occurs. One new and unexpected result is that when the solution to the Merton problem (without transaction costs) involves a leveraged position, and when transaction costs are large, the location of the boundary at which sales of the risky asset occur is independent of the transaction cost on purchases.
Henderson V, Hobson D, Tse ASL, 2018, Probability weighting, stop-loss and the disposition effect, Journal of Economic Theory, Vol: 178, Pages: 360-397, ISSN: 0022-0531
In this paper we study a continuous-time, optimal stopping model of an asset sale with prospect theory preferences under pre-commitment. We show for a wide range of value and probability weighting functions, including those of Tversky and Kahneman (1992), that the optimal prospect takes the form of a stop-loss threshold and a distribution over gains. It is skewed with a long right tail. This is consistent with both the widespread use of stop-loss strategies in financial markets, and recent experimental evidence. Moreover, our model with probability weighting in tandem with the S-shaped value function makes predictions for the disposition effect which match in magnitude that calculated by Odean (1998).
Henderson V, Hobson D, Tse ASL, 2017, Randomized strategies and prospect theory in a dynamic context, JOURNAL OF ECONOMIC THEORY, Vol: 168, Pages: 287-300, ISSN: 0022-0531
So MKP, Tse ASL, 2009, Dynamic modeling of tail risk: Applications to China, Hong Kong and other Asian markets, Asia-Pacific Financial Markets, Vol: 16, Pages: 183-210, ISSN: 1387-2834
In this paper, we study the extreme dependence between the markets in Hong Kong, Shanghai, Shenzhen, Taiwan and Singapore. The tail dependence coefficient (TDC), which measures how likely financial returns move together in extreme market conditions, is modeled dynamically using the Multivariate Generalized Autoregressive Conditional Heteroscedasticity model with the time-varying correlation matrix of Tse and Tsui (Journal of Business & Economic Statistics, 20(3):351-363, 2002). The time paths of the TDC indicate that Hong Kong stocks had the highest extreme dependence during the Asian financial crisis and their TDCs have followed an increasing trend since 2006. The results in this paper also show that the TDC pattern of Singapore with the other markets is very similar to the TDC pattern of Hong Kong with the other markets. An increasing trend in the extreme dependence between Shanghai A Share Index and Shanghai B Share Index and between the Hang Seng Index and the Hong Kong China Enterprise Index is observed from 2002 to 2007. A substantial rise in the TDC between Shenzhen A Share Index and Shenzhen B Share Index was recorded after the China market reforms in 2005. Our TDC modeling with Asian market data provides evidence that Asian markets are becoming integrated and their extreme co-movements during financial turmoil are becoming stronger. © Springer Science+Business Media, LLC. 2009.
Henderson V, Hobson D, Tse ASL, Randomized Strategies and Prospect Theory in a Dynamic Context, SSRN Electronic Journal
Henderson V, Hobson D, Tse ASL, Probability Weighting, Stop-Loss and the Disposition Effect, SSRN Electronic Journal
Lambrecht B, Tse ASL, Liquidation, Bailout, and Bail-In: Insolvency Resolution Mechanisms and Managerial Risk-Taking, SSRN Electronic Journal
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