Abstract
Given the striking effects of the recent financial turmoil, and the importance of value and growth portfolios for both local and international portfolio allocation, we investigate the effects of systemic jumps on the optimal portfolio investment strategies across value and growth equity portfolios. We find that the cost of ignoring systemic jumps is not substantial, unless the portfolio is highly levered and the average size amplitude of the jump is large enough. From the optimal asset allocation point of view, it seems more important the effects of few but relatively large jumps than highly frequent but small jumps. Indeed, the period in which the value premium is higher coincides with a period of few, but large and positive average size jumps for value stocks, and negative and very large average size jumps for growth stocks.
Highlights
The value premium is one of the most relevant anomalies discussed in the asset pricing literature
Given the striking effects of the recent financial turmoil, and the importance of value and growth portfolios for both local and international portfolio allocation, we investigate the effects of systemic jumps on the optimal portfolio investment strategies across value and growth equity portfolios
The period in which the value premium is higher coincides with a period of few, but large and positive average size jumps for value stocks, and negative and very large average size jumps for growth stocks
Summary
The value premium is one of the most relevant anomalies discussed in the asset pricing literature. We find that the effects of systemic jumps are not negligible from 1982 to 1997 for low levels of risk aversion (highly levered portfolios) when the frequency of jumps is small but its average size is large This period is characterized by an especially large value premium. This section first present a model of asset equity returns which is based on the asset pricing model proposed in [6] This model introduces systemic risk by imposing jumps that occur simultaneously across all assets and allowing for a varying distribution of the jump size across all portfolios. We discuss optimal portfolio allocation given that the underlying assets follow a jumpdiffusion process with systemic jumps We compare these results relative to the case in which asset returns follow a pure diffusion process
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