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Asset allocation in markets with contagion: The interplay between volatilities, jump intensities, and correlations

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  • Patrick Konermann
  • Christoph Meinerding
  • Olga Sedova

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.

Suggested Citation

  • Patrick Konermann & Christoph Meinerding & Olga Sedova, 2013. "Asset allocation in markets with contagion: The interplay between volatilities, jump intensities, and correlations," Review of Financial Economics, John Wiley & Sons, vol. 22(1), pages 36-46, January.
    • Handle: RePEc:wly:revfec:v:22:y:2013:i:1:p:36-46
    DOI: 10.1016/j.rfe.2012.08.001
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    Cited by:

    1. Aboura, Sofiane & Chevallier, Julien, 2014. "Cross-market spillovers with ‘volatility surprise’," Review of Financial Economics, Elsevier, vol. 23(4), pages 194-207.
    2. Dungey, Mardi & Flavin, Thomas J. & Lagoa-Varela, Dolores, 2020. "Are banking shocks contagious? Evidence from the eurozone," Journal of Banking & Finance, Elsevier, vol. 112(C).
    3. Anna Battauz & Alessandro Sbuelz, 2018. "Non†myopic portfolio choice with unpredictable returns: The jump†to†default case," European Financial Management, European Financial Management Association, vol. 24(2), pages 192-208, March.
    4. Sofiane Aboura & Julien Chevallier, 2014. "Cross-Market Spillovers with ‘Volatility Surprise’," Working Papers hal-04141310, HAL.
    5. repec:ipg:wpaper:2014-469 is not listed on IDEAS

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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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