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Partial information about contagion risk,self-exciting processes and portfolio optimization
Affiliation:1. Finance Center Münster, Westfälische Wilhelms-Universität Münster, Universitätsstr. 14-16, 48143 Münster, Germany;2. Department of Finance, Goethe University, 60323 Frankfurt am Main, Germany;1. Institute of Applied Mathematics, Academy of Mathematics and Systems Sciences, Academia Sinica, PR China;2. Institute of Mathematics, Jagiellonian University, Łojasiewicza 6, 30-348 Kraków, Poland;3. Department of Mathematics, Faculty of Science and Technology, University of Macau, Av. Padre Tomás Pereira, Taipa Macau, China;1. Department of Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario, Canada, N2L 3G1;2. Department of Mathematics and Statistics, Concordia University, Montreal, Quebec, Canada, H3G 1M8;1. School of Risk and Actuarial Studies and CEPAR, Australian School of Business, University of New South Wales, Sydney, NSW 2052, Australia;2. School of Mathematical Sciences and LPMC, Nankai University, Tianjin, 300071, PR China;3. Department of Mathematics, Southeast University, Nanjing, 210096, PR China;4. Cass Business School, City University London, 106 Bunhill Row, London, EC1Y 8TZ, United Kingdom;5. Department of Applied Finance and Actuarial Studies, Faculty of Business and Economics, Macquarie University, Sydney, NSW 2109, Australia
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
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