What is the Impact of Stock Market Contagion on an Investor's Portfolio Choice?

Branger Nicole, Kraft Holger, Meinerding Christoph


Zusammenfassung
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.

Schlüsselwörter
Asset allocation; Jumps; Contagion; Model risk



Publikationstyp
Forschungsartikel (Zeitschrift)

Begutachtet
Ja

Publikationsstatus
Veröffentlicht

Jahr
2009

Fachzeitschrift
Insurance: Mathematics and Economics

Band
2009

Ausgabe
45

Erste Seite
1

Letzte Seite
94

Sprache
Englisch

ISSN
0167-6687

DOI

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