Optimal portfolios when variances and covariances can jump
Frank Thomas Seifried and
Journal of Economic Dynamics and Control, 2017, vol. 85, issue C, 59-89
We analyze the optimal portfolio choice in a multi-asset Wishart-model in which return variances and correlations are stochastic and subject to jump risk. The optimal portfolio is characterized by the positions in stock diffusion risk, variance-covariance diffusion risk, and jump risk. We find that including jumps in the second moments changes the optimal positions and particularly variance-covariance hedging demands significantly. Erroneously omitting these jumps gives rise to substantial model risk. Furthermore, variance-covariance jump risk can have a significant impact on potential utility gains when the market is completed by adding derivatives. As a robustness check, we compare our results to those obtained for other parametrizations of Wishart-models from the literature as well as to various single-asset models.
Keywords: Optimal portfolio choice; Stochastic correlation; Wishart process; Derivatives; Jump risk; Covariance jumps (search for similar items in EconPapers)
JEL-codes: G11 G13 (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:85:y:2017:i:c:p:59-89
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