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Optimal portfolios when variances and covariances can jump

Nicole Branger, Matthias Muck, Frank Thomas Seifried and Stefan Weisheit

Journal of Economic Dynamics and Control, 2017, vol. 85, issue C, 59-89

Abstract: 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)
Date: 2017
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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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