Has anybody looked at Nassim Taleb's work on stop-losses?
His approach is quite unique. It is one of the only efforts not based on an empirical study, and it uses the same methods that model quants use every day. Almost every other paper in the area (several written by Nobel Prize winners) is based on an empirical study or econometrics.
I think it will have a huge impact, not just that single paper, but in changing the mindset of quants who have traditionally focused almost entirely on options and the SELL side.
About a year ago, I realised that almost nothing theoretical was known about the stock market. Banks with over 100 quants in the derivatives area and trillions of dollars of assets in wealth management do not know even the most basic facts about how a stop-loss or any other market order type works. They have no understanding of what Nassim describes regarding the absorbing barrier and how it fundamentally changes the probability distribution of profits/losses. They have no idea what happens if the client sees a different market to the growth=10% one that they tell their clients about in glossy wealth-management brochures. The beautiful thing for these companies is that nobody likes talking about their losses, so even if clients do move on, they do not talk about it, so the glossy brochures never have to change! It's even more gruesome in the spread-betting, retail stock/option trading zoo, where 80+% of participants lose money - most of it due to poor bankroll management.
I expect that Ed Thorp, D.E.Shaw, and Jim Simons know/knew this, but most quants do not know and academics do not, and almost nothing has been published on it. Books on derivative theory have empty chapters when it comes to any of it, apart from Kelly and diversification. This is the extent of what is known from the quantitative finance industry. It is incredible because it is relevant to far more individuals than anything in the mainstream option pricing/SELL side.
Stop-losses are used by perhaps 25-50% of all people who open a position. Hundreds of people on YouTube provide advice. Everybody on YouTube is an expert and has some TA magic leaf theory for why they place their stop at spot-3.75% or somewhere else. Every five years or so, an academic reminds everybody that it is all a waste of time because nobody can outperform buy-and-hold.
A long position + stop-loss is equivalent to a perpetual down-and-out call. Delaying the purchase of a stock until it rises by 5% is an IN option. The list of interesting problems, many of which do not occur in the traditional option-pricing universe, is extensive.
As someone who has worked in the same area that Nassim's latest paper focuses on, it is very encouraging. He has 1.5M views already, but I expect that will grow.
Amen