Asset Allocation in Markets with Contagion: The Interplay between Volatilities, Jump Intensities, and Correlations

Posted: 25 Nov 2011 Last revised: 15 Apr 2013

See all articles by Patrick Konermann

Patrick Konermann

BI Norwegian Business School

Christoph Meinerding

Deutsche Bundesbank

Olga Sedova

University of Muenster - Finance Center Muenster

Date Written: June 28, 2012

Abstract

We study the impact of financial contagion on the dynamic asset allocation problem of a CRRA investor facing an incomplete market with two risky assets. We apply a Markov chain regime-switching framework with state-dependent jump intensities, diffusion volatilities and diffusion correlations. The key model feature that a switch to the bad contagion regime is triggered by a loss in one of the risky assets allows for the implementation of a hedging demand against contagion risk. Moreover, a state-dependent diffusion correlation combined with heterogeneity in jump intensities and volatilities can, e.g., generate a flight to quality effect upon a systemic jump.

Keywords: Asset Allocation, Portfolio Choice, Contagion, Systemic Risk, Regime Switching

JEL Classification: G01, G11

Suggested Citation

Konermann, Patrick and Meinerding, Christoph and Sedova, Olga, Asset Allocation in Markets with Contagion: The Interplay between Volatilities, Jump Intensities, and Correlations (June 28, 2012). Review of Financial Economics, Vol. 22, Issue 1, January 2013, 36-46, Available at SSRN: https://ssrn.com/abstract=1964616 or http://dx.doi.org/10.2139/ssrn.1964616

Patrick Konermann

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Christoph Meinerding (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Olga Sedova

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
934
PlumX Metrics