OPTIMAL PORTFOLIOS UNDER THE THREAT OF A CRASH

Ralf Korn () and Paul Wilmott ()
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Ralf Korn: Fachbereich Mathematik, Universität Kaiserslautern, 67653 Kaiserslautern, Germany
Paul Wilmott: Wilmott Associates, London, UK

International Journal of Theoretical and Applied Finance (IJTAF), 2002, vol. 05, issue 02, 171-187

Abstract: We consider the determination of optimal portfolios under the threat of a crash. Our main assumption is that upper bounds for both the crash size and the number of crashes occurring before the time horizon are given. We make no probabilistic assumption on the crash size or the crash time distribution. The optimal strategies in the presence of a crash possibility are characterized by a balance problem between insurance against the crash and good performance in the crash-free situation. Explicit solutions for the log-utility case are given. Our main finding is that constant portfolios are no longer optimal ones.

Keywords: Optimal portfolios; crash modelling; log-utility; equilibrium strategies; worst-case scenario (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1142/S0219024902001407

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