Partial information about contagion risk, self-exciting processes and portfolio optimization

Nicole Branger, Holger Kraft and Christoph Meinerding

Journal of Economic Dynamics and Control, 2014, vol. 39, issue C, 18-36

Abstract: This paper compares two classes of models that allow for additional channels of correlation between asset returns: regime switching models with jumps and models with contagious jumps. Both classes of models involve a hidden Markov chain that captures good and bad economic states. The distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously. We show that in this framework the filtered loss intensities have dynamics similar to self-exciting processes. Besides, we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering.

Keywords: Asset allocation; Contagion; Nonlinear filtering; Hidden state; Self-exciting processes (search for similar items in EconPapers)
JEL-codes: G01 G11 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:39:y:2014:i:c:p:18-36

DOI: 10.1016/j.jedc.2013.10.005

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