Earning the Right Premium on the Right Factor in Portfolio Planning

38 Pages Posted: 1 Feb 2010 Last revised: 17 Mar 2010

See all articles by Nicole Branger

Nicole Branger

University of Muenster - Finance Center Muenster

Alexandra Hansis

Goethe University Frankfurt - House of Finance

Date Written: February 1, 2010

Abstract

The optimal portfolio as well as the utility from trading stocks and derivatives depends on the risk factors and on their market prices of risk. We analyze this dependence for a CRRA investor in a model setup with stochastic volatility and stochastic jumps in the stock price and its volatility. We find that both the decomposition of the variance and the decomposition of the equity risk premium into a diffusion component and a jump risk component matter. We furthermore show that the same holds true for the compartment of the latter into its various elements. Additionally, we show that the structure of the optimal exposures to jump risk crucially depends on which elements of jump risk are priced. In a complete market, changing the assumption on whether jump intensity risk, jump size risk, or jump variance risk are priced reverses the dependence of the optimal jump risk exposures on the jump size (in the stock price) completely. The function changes from flat to increasing to (inversely) U-shaped.

Keywords: stochastic volatility, jumps, market prices of risk, asset allocation, optimal exposures

JEL Classification: G11

Suggested Citation

Branger, Nicole and Hansis, Alexandra, Earning the Right Premium on the Right Factor in Portfolio Planning (February 1, 2010). Available at SSRN: https://ssrn.com/abstract=1545760 or http://dx.doi.org/10.2139/ssrn.1545760

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Alexandra Hansis (Contact Author)

Goethe University Frankfurt - House of Finance ( email )

Campus Westend, Grueneburgplatz 1
Uni-Postfach H 13
Frankfurt, 60323
Germany

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