Optimal portfolio allocation with volatility and co-jump risk that Markowitz would like
I. Oliva and
Journal of Economic Dynamics and Control, 2018, vol. 94, issue C, 242-256
We study a continuous time optimal portfolio allocation problem with volatility and co-jump risk, allowing prices, variances and covariances to jump simultaneously. Differently from the traditional approach, we deviate from affine models by specifying a flexible Wishart jump-diffusion for the co-precision (the inverse of the covariance matrix). The optimal portfolio weights that solve the dynamic programming problem are genuinely dynamic and proportional to the instantaneous co-precision, reconciling optimal dynamic allocation with the static Markowitz-type economic intuition. An application to the optimal allocation problem across hedge fund investment styles illustrates the importance of having jumps in volatility associated with jumps in price.
Keywords: Asset allocation; Stochastic volatility; Co-jumps; Wishart process; Dynamic programming; Hedge funds (search for similar items in EconPapers)
JEL-codes: C61 G11 (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:94:y:2018:i:c:p:242-256
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