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http://ssrn.com/abstract=354388
 
 

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Systemic Risk and International Portfolio Choice


Sanjiv Ranjan Das


Santa Clara University - Leavey School of Business

Raman Uppal


EDHEC Business School; Centre for Economic Policy Research (CEPR)

July 2002

AFA 2003 Washington, DC Meetings

Abstract:     
Returns on international equities are characterized by jumps; moreover, these jumps tend to occur at the same time across countries leading to systemic risk. In this paper, we evaluate whether systemic risk reduces substantially the gains from international diversification. First, in order to capture these stylized facts, we develop a model of international equity returns using a multivariate system of jump-diffusion processes where the arrival of jumps is simultaneous across assets. Second, we determine an investor's optimal portfolio for this model of returns. Third, we show how one can estimate the model using the method of moments. Finally, we illustrate our portfolio optimization and estimation procedure by analyzing portfolio choice across a riskless asset, the US equity index, and five international indexes. Our main finding is that, while systemic risk affects the allocation of wealth between the riskless and risky assets, it has a small effect on the composition of the portfolio of only-risky assets, and reduces marginally the gains to a US investor from international diversification: For an investor with a relative risk aversion of 3 and a horizon of one year, the certainty-equivalent cost of ignoring systemic risk is of the order $1 for every $1000 of initial investment. These results are robust to whether the international indexes are for developed or emerging countries, to constraints on borrowing and shortselling, and to reasonable deviations in the value of the parameters around their point estimates; the cost increases with the investment horizon and decreases with risk aversion.

Number of Pages in PDF File: 55

Keywords: asset allocation, contagion, emerging markets, skewness, jump-diffusion processes

JEL Classification: G11, G15, F31

working papers series


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Date posted: November 30, 2002  

Suggested Citation

Das, Sanjiv Ranjan and Uppal , Raman, Systemic Risk and International Portfolio Choice (July 2002). AFA 2003 Washington, DC Meetings. Available at SSRN: http://ssrn.com/abstract=354388 or http://dx.doi.org/10.2139/ssrn.354388

Contact Information

Sanjiv Ranjan Das (Contact Author)
Santa Clara University - Leavey School of Business ( email )
Department of Finance
321E Lucas Hall
Santa Clara, CA 95053
United States
HOME PAGE: http://algo.scu.edu/~sanjivdas/
Raman Uppal
EDHEC Business School ( email )
10 Fleet Place, Ludgate
London, EC4M 7RB
United Kingdom
+44 20 7871 6744 (Phone)
90-98 Goswell Road
London, EC1V 7RR
United Kingdom
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