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The effects of systemic crises when investors can be crisis ignorant

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Author Info
Kole, H.J.W.G.
Koedijk, C.G.
Verbeek, M.J.C.M. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)

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Abstract

Systemic crises can largely affect asset allocations due to the rapid deterioration of the risk-return trade-off. We investigate the effects of systemic crises, interpreted as global simultaneous shocks to financial markets, by introducing an investor adopting a crisis ignorant or crisis conscious strategy. Including the possibility of a systemic crisis is a substantial improvement. Investments in risky assets fall, while allocations to countries less sensitive to a crisis grow relatively. An increasing probability of a crisis exacerbates these effects. The certainty equivalent costs of ignoring systemic crises are large, ranging from 0.65% per year unconditionally, to over 5% per month conditionally on a high probability for the occurrence of a crisis.

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Publisher Info
Paper provided by Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam. in its series Research Paper with number ERS-2004-027-F&A Revision_Date: 2009-10-12.

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Date of creation: 17 Apr 2004
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Handle: RePEc:dgr:eureri:30001393

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Related research
Keywords: asset allocation; systemic risk; international finance; regime switching;

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