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Dynamic Asset Allocation with Event Risk

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  • Liu, Jun
  • Longstaff, Francis
  • Pan, Jun
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    Abstract

    An inherent risk facing investors in financial markets is that a major event may trigger a large abrupt change in stock prices and market volatility. This paper studies the implications of jumps in prices and volatility on investment strategies. Using the event-risk framework of Duffie, Pan, and Singleton, we provide an analytical solution to the optimal portfolio problem. We find that event risk dramatically affects the optimal strategy. An investor facing event risk is less willing to take leveraged or short positions. In addition, the investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends elements of both dynamic and buy-and-hold portfolio strategies. Jumps in prices and volatility both have an important influence on the optimal strategy.

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    Bibliographic Info

    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt9fm6t5nb.

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    Date of creation: 01 Aug 2001
    Date of revision:
    Handle: RePEc:cdl:anderf:qt9fm6t5nb

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    Web page: http://www.escholarship.org/repec/anderson_fin/
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    Related research

    Keywords: dynamic choice; risk aversion; stochastic volatility;

    References

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    1. Campbell, John & Viceira, Luis, 1999. "Consumption and Portfolio Decisions When Expected Returns are Time Varying," Scholarly Articles 3163266, Harvard University Department of Economics.
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    8. Brennan, Michael J. & Xia, Yihong, 1998. "Resolution of a Financial Puzzle," University of California at Los Angeles, Anderson Graduate School of Management qt5497w2bh, Anderson Graduate School of Management, UCLA.
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    Cited by:
    1. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, vol. 63(1), pages 3-50, January.

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