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Partial information about contagion risk, self-exciting processes and portfolio optimization

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  • Branger, Nicole
  • Kraft, Holger
  • Meinerding, Christoph
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    Abstract

    This paper compares two classes of models that allow for additional channels of correlation between asset returns: regime switching models with jumps and models with contagious jumps. Both classes of models involve a hidden Markov chain that captures good and bad economic states. The distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously. We show that in this framework the filtered loss intensities have dynamics similar to self-exciting processes. Besides, we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

    Volume (Year): 39 (2014)
    Issue (Month): C ()
    Pages: 18-36

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    Handle: RePEc:eee:dyncon:v:39:y:2014:i:c:p:18-36

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    Web page: http://www.elsevier.com/locate/jedc

    Related research

    Keywords: Asset allocation; Contagion; Nonlinear filtering; Hidden state; Self-exciting processes;

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