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Sharpe Ratio Maximization and Expected Utility when Asset Prices have Jumps



We analyze portfolio strategies which are locally optimal, meaning that they maximize the Sharpe ratio in a general continuous time jump-diffusion framework. These portfolios are characterized explicitly and compared to utility based strategies. In the presence of jumps, maximizing the Sharpe ratio is shown to be generally inconsistent with maximizing expected utility, but this is shown to depend strongly on market completeness and whether event risk is priced.

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  • Morten Christensen & Eckhard Platen, 2005. "Sharpe Ratio Maximization and Expected Utility when Asset Prices have Jumps," Research Paper Series 170, Quantitative Finance Research Centre, University of Technology, Sydney.
  • Handle: RePEc:uts:rpaper:170

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    1. John H. Cochrane & Jesus Saa-Requejo, 2000. "Beyond Arbitrage: Good-Deal Asset Price Bounds in Incomplete Markets," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 79-119, February.
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    3. Morten Christensen & Eckhard Platen, 2004. "A General Benchmark Model for Stochastic Jump Sizes," Research Paper Series 139, Quantitative Finance Research Centre, University of Technology, Sydney.
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    5. Eckhard Platen, 2004. "Capital Asset Pricing for Markets with Intensity Based Jumps," Research Paper Series 143, Quantitative Finance Research Centre, University of Technology, Sydney.
    6. Nielsen, Lars Tyge & Vassalou, Maria, 2004. "Sharpe Ratios and Alphas in Continuous Time," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(01), pages 103-114, March.
    7. J. Tobin, 1958. "Liquidity Preference as Behavior Towards Risk," Review of Economic Studies, Oxford University Press, vol. 25(2), pages 65-86.
    8. Martin Kulldorff & Ajay Khanna, 1999. "A generalization of the mutual fund theorem," Finance and Stochastics, Springer, vol. 3(2), pages 167-185.
    9. Holger Kraft & Mogens Steffensen, 2005. "How to Invest Optimally in Corporate Bonds: A Reduced-Form Approach," FRU Working Papers 2005/07, University of Copenhagen. Department of Economics. Finance Research Unit.
    10. Schweizer, Martin, 1992. "Martingale densities for general asset prices," Journal of Mathematical Economics, Elsevier, vol. 21(4), pages 363-378.
    11. Back, Kerry, 1991. "Asset pricing for general processes," Journal of Mathematical Economics, Elsevier, vol. 20(4), pages 371-395.
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