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Optimal portfolios when variances and covariances can jump

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  • Branger, Nicole
  • Muck, Matthias
  • Seifried, Frank Thomas
  • Weisheit, Stefan

Abstract

We analyze the optimal portfolio choice in a multi-asset Wishart-model in which return variances and correlations are stochastic and subject to jump risk. The optimal portfolio is characterized by the positions in stock diffusion risk, variance-covariance diffusion risk, and jump risk. We find that including jumps in the second moments changes the optimal positions and particularly variance-covariance hedging demands significantly. Erroneously omitting these jumps gives rise to substantial model risk. Furthermore, variance-covariance jump risk can have a significant impact on potential utility gains when the market is completed by adding derivatives. As a robustness check, we compare our results to those obtained for other parametrizations of Wishart-models from the literature as well as to various single-asset models.

Suggested Citation

  • Branger, Nicole & Muck, Matthias & Seifried, Frank Thomas & Weisheit, Stefan, 2017. "Optimal portfolios when variances and covariances can jump," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 59-89.
  • Handle: RePEc:eee:dyncon:v:85:y:2017:i:c:p:59-89
    DOI: 10.1016/j.jedc.2017.09.008
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    Cited by:

    1. Arouri, Mohamed & M’saddek, Oussama & Nguyen, Duc Khuong & Pukthuanthong, Kuntara, 2019. "Cojumps and asset allocation in international equity markets," Journal of Economic Dynamics and Control, Elsevier, vol. 98(C), pages 1-22.
    2. repec:eee:dyncon:v:94:y:2018:i:c:p:242-256 is not listed on IDEAS
    3. repec:wly:jfutmk:v:39:y:2019:i:1:p:128-146 is not listed on IDEAS
    4. repec:kap:annfin:v:15:y:2019:i:3:d:10.1007_s10436-019-00350-3 is not listed on IDEAS

    More about this item

    Keywords

    Optimal portfolio choice; Stochastic correlation; Wishart process; Derivatives; Jump risk; Covariance jumps;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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