Asset allocation in markets with contagion: The interplay between volatilities, jump intensities, and correlations

Patrick Konermann, Christoph Meinerding and Olga Sedova

Review of Financial Economics, 2013, vol. 22, issue 1, 36-46

Abstract: 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.

Keywords: Asset allocation; Portfolio choice; Contagion; Systemic risk; Regime switching (search for similar items in EconPapers)
JEL-codes: G01 G11 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:revfin:v:22:y:2013:i:1:p:36-46

DOI: 10.1016/j.rfe.2012.08.001

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