Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/76793 
Year of Publication: 
2009
Series/Report no.: 
Working Paper Series: Finance & Accounting No. 198
Publisher: 
Johann Wolfgang Goethe-Universität Frankfurt am Main, Fachbereich Wirtschaftswissenschaften, Frankfurt a. M.
Abstract: 
Stocks are exposed to the risk of sudden downward jumps. Additionally, a crash in one stock (or index) can increase the risk of crashes in other stocks (or indices). Our paper explicitly takes this contagion risk into account and studies its impact on the portfolio decision of a CRRA investor both in complete and in incomplete market settings. We find that the investor significantly adjusts his portfolio when contagion is more likely to occur. Capturing the time dimension of contagion, i.e. the time span between jumps in two stocks or stock indices, is thus of first-order importance when analyzing portfolio decisions. Investors ignoring contagion completely or accounting for contagion while ignoring its time dimension suffer large and economically significant utility losses. These losses are larger in complete than in incomplete markets, and the investor might be better off if he does not trade derivatives. Furthermore, we emphasize that the risk of contagion has a crucial impact on investors' security demands, since it reduces their ability to diversify their portfolios.
Subjects: 
Asset Allocation
Jumps
Contagion
Model Risk
JEL: 
G12
G13
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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