Worst-Case Optimal Investment with a Random Number of Crashes
Statistics and Probability Letters, Volume 90, pp. 140-148, July 2014.
Posted: 21 Nov 2013 Last revised: 2 May 2016
Date Written: November 24, 2013
We study a portfolio optimization problem in a market which is under the threat of crashes. At random times, the investor receives a warning that a crash in the risky asset might occur. We construct a strategy which renders the investor indifferent about an immediate crash of maximum size and no crash at all. We then verify that this strategy outperforms every other trading strategy using a direct comparison approach. We conclude with numerical examples and calculating the costs of hedging against crashes.
Keywords: optimal investment, market crashes, worst-case scenario, financial bubbles
JEL Classification: G11
Suggested Citation: Suggested Citation