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Dynamic Asset Allocation With Event Risk

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Author Info
Jun Liu
Francis A. Longstaff
Jun Pan
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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9103.

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Date of creation: Aug 2002
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Handle: RePEc:nbr:nberwo:9103

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G1 - Financial Economics - - General Financial Markets

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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. [Downloadable!] (restricted)
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  1. Qiang Dai & Kenneth J. Singleton & Wei Yang, 2004. "Regime shifts in a dynamic term structure model of U.S. Treasury bond yields," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
  2. Liu, Jun & Pan, Jun, 2003. "Dynamic Derivative Strategies," Working papers 4334-02, Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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