Faculty of Economics and Business Administration Publications Database

Partial information about contagion risk, self-exciting processes and portfolio optimization

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Authors:
Branger, Nicole
Source:
Volume: 39
Pages: 18 - 36
Month: February
ISSN-Print: 0165-1889
Link External Source: Online Version
Year: 2014
Keywords: Asset allocation; Contagion; Nonlinear filtering; Hidden state; Self-exciting processes
Abstract:

This paper compares two classes of models that allow for additional channels of correlation between asset returns: regime switching models with jumps and models with contagious jumps. Both classes of models involve a hidden Markov chain that captures good and bad economic states. The distinctive feature of a model with contagious jumps is that large negative returns and unobservable transitions of the economy into a bad state can occur simultaneously. We show that in this framework the filtered loss intensities have dynamics similar to self-exciting processes. Besides, we study the impact of unobservable contagious jumps on optimal portfolio strategies and filtering.

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