## Publications

11 results found

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 riskāaverse 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

Tse ASL, Zheng H, Speculative Trading, Prospect Theory and Transaction Costs

A speculative agent with Prospect Theory preference chooses the optimal timeto purchase and then to sell an indivisible risky asset to maximize theexpected utility of the round-trip profit net of transaction costs. Theoptimization problem is formulated as a sequential optimal stopping problem andwe provide a complete characterization of the solution. Depending on thepreference and market parameters, the optimal strategy can be "buy and hold","buy low sell high", "buy high sell higher" or "no trading". Behavioralpreference and market friction interact in a subtle way which yields surprisingimplications on the agent's trading patterns. For example, increasing themarket entry fee does not necessarily curb speculative trading, but instead itmay induce a higher reference point under which the agent becomes morerisk-seeking and in turn is more likely to trade.

Henderson V, Hobson D, Tse ASL, Randomized Strategies and Prospect Theory in a Dynamic Context, *SSRN Electronic Journal*

Lambrecht B, Tse ASL, Liquidation, Bailout, and Bail-In: Insolvency Resolution Mechanisms and Managerial Risk-Taking, *SSRN Electronic Journal*

Armstrong J, Brigo D, Tse ASL, The importance of dynamic risk constraints for limited liability operators

Previous literature shows that prevalent risk measures such as Value at Riskor Expected Shortfall are ineffective to curb excessive risk-taking by atail-risk-seeking trader with S-shaped utility function in the context ofportfolio optimisation. However, these conclusions hold only when theconstraints are static in the sense that the risk measure is just applied tothe terminal portfolio value. In this paper, we consider a portfoliooptimisation problem featuring S-shaped utility and a dynamic risk constraintwhich is imposed throughout the entire trading horizon. Provided that the riskcontrol policy is sufficiently strict relative to the asset performance, thetrader's portfolio strategies and the resulting maximal expected utility can beeffectively constrained by a dynamic risk measure. Finally, we argue thatdynamic risk constraints might still be ineffective if the trader has access toa derivatives market.

Henderson V, Hobson D, Tse ASL, Probability Weighting, Stop-Loss and the Disposition Effect, *SSRN Electronic Journal*

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