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Asset allocation in markets with contagion: The interplay between volatilities, jump intensities, and correlations
Author(s) -
Konermann Patrick,
Meinerding Christoph,
Sedova Olga
Publication year - 2013
Publication title -
review of financial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.347
H-Index - 41
eISSN - 1873-5924
pISSN - 1058-3300
DOI - 10.1016/j.rfe.2012.08.001
Subject(s) - jump , economics , financial contagion , markov chain , asset (computer security) , jump diffusion , econometrics , asset allocation , financial market , diffusion , financial economics , finance , computer science , portfolio , mathematics , statistics , physics , computer security , quantum mechanics , thermodynamics
We study the impact of financial contagion on the dynamic asset allocation problem of a CRRA investor facing an incomplete market with two risky assets. We apply a Markov chain regime‐switching framework with state‐dependent jump intensities, diffusion volatilities and diffusion correlations. The key model feature that a switch to the bad contagion regime is triggered by a loss in one of the risky assets allows for the implementation of a hedging demand against contagion risk. Moreover, a state‐dependent diffusion correlation combined with heterogeneity in jump intensities and volatilities can, e.g., generate a flight to quality effect upon a systemic jump.