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Partial Information about Contagion Risk, Self-Exciting Processes and Portfolio Optimization

SAFE Working Paper No. 28

42 Pages Posted: 2 Jul 2010 Last revised: 27 Aug 2013

Nicole Branger

University of Muenster - Finance Center Muenster

Holger Kraft

Goethe University Frankfurt

Christoph Meinerding

Deutsche Bundesbank

Date Written: April 18, 2013

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.

Keywords: Asset Allocation, Contagion, Nonlinear Filtering, Hidden State, Self-exciting Processes

JEL Classification: G01, G11

Suggested Citation

Branger, Nicole and Kraft, Holger and Meinerding, Christoph, Partial Information about Contagion Risk, Self-Exciting Processes and Portfolio Optimization (April 18, 2013). SAFE Working Paper No. 28. Available at SSRN: https://ssrn.com/abstract=1633479 or http://dx.doi.org/10.2139/ssrn.1633479

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

Holger Kraft

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Christoph Meinerding (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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