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Dynamic Asset Allocation with Event Risk

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Author Info

  • Jun Liu

    (Anderson School at UCLA,)

  • Francis A. Longstaff

    (Anderson School at UCLA,)

  • Jun Pan

    (MIT Sloan School of Management)

Abstract

Major events often trigger abrupt changes in stock prices and volatility. We study the implications of jumps in prices and volatility on investment strategies. Using the event-risk framework of Duffie, Pan, and Singleton (2000), we provide analytical solutions to the optimal portfolio problem. Event risk dramatically affects the optimal strategy. An investor facing event risk is less willing to take leveraged or short positions. The investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends both dynamic and buy-and-hold strategies. Jumps in prices and volatility both have important effects. Copyright 2003 by the American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 58 (2003)
Issue (Month): 1 (02)
Pages: 231-259

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Handle: RePEc:bla:jfinan:v:58:y:2003:i:1:p:231-259

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  1. Balduzzi, Pierluigi & Lynch, Anthony W., 1999. "Transaction costs and predictability: some utility cost calculations," Journal of Financial Economics, Elsevier, vol. 52(1), pages 47-78, April.
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