Abstract

http://ssrn.com/abstract=2157038
 
 

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Portfolio Choice in Markets with Contagion


Yacine Ait-Sahalia


Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Thomas R. Hurd


McMaster University - Department of Mathematics and Statistics

September 26, 2012


Abstract:     
We consider the problem of optimal investment and consumption in a class of multidimensional jump-diffusion models in which asset prices are subject to mutually exciting jump processes. This captures a type of contagion where each downward jump in an asset's price results in increased likelihood of further jumps, both in that asset and in the other assets. We solve in closed-form the dynamic consumption-investment problem of a log-utility investor in such a contagion model, prove a theorem verifying its optimality and discuss features of the solution, including flight-to-quality. The exponential and power utility investors are also considered: in these cases, the optimal strategy can be characterized as a distortion of the strategy of a corresponding non-contagion investor.

Number of Pages in PDF File: 25

Keywords: Merton problem, jumps, Hawkes process, mutual excitation, contagion, flight-to-quality

JEL Classification: G11, G01

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Date posted: October 5, 2012 ; Last revised: November 18, 2012

Suggested Citation

Ait-Sahalia, Yacine and Hurd, Thomas R., Portfolio Choice in Markets with Contagion (September 26, 2012). Available at SSRN: http://ssrn.com/abstract=2157038 or http://dx.doi.org/10.2139/ssrn.2157038

Contact Information

Yacine Ait-Sahalia
Princeton University - Department of Economics ( email )
Fisher Hall
Princeton, NJ 08544
United States
609-258-4015 (Phone)
609-258-5398 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Thomas R. Hurd (Contact Author)
McMaster University - Department of Mathematics and Statistics ( email )
Canada
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