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Semi-analytical solutions for dynamic portfolio choice in jump-diffusion models and the optimal bond-stock mix

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Hong, Yi and Jin, Xing (2018) Semi-analytical solutions for dynamic portfolio choice in jump-diffusion models and the optimal bond-stock mix. European Journal of Operational Research, 265 (1). pp. 389-398. doi:10.1016/j.ejor.2017.08.010

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Official URL: https://doi.org/10.1016/j.ejor.2017.08.010

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Abstract

This paper studies the optimal portfolio selection problem in jump-diffusion models where an investor has a HARA utility function, and there are potentially a large number of assets and state variables. More specifically, we incorporate jumps into both stock returns and state variables, and then derive semi-analytical solutions for the optimal portfolio policy up to solving a set of ordinary differential equations to greatly facilitate economic insights and empirical applications of jump-diffusion models. To examine the effect of jump risk on investors’ behavior, we apply our results to the bond-stock mix problem and particularly revisit the bond/stock ratio puzzle in jump-diffusion models. Our results cast new light on this puzzle that unlike pure-diffusion models, it cannot be rationalized by the hedging demand assumption due to the presence of jumps in stock returns.

Item Type: Journal Article
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Divisions: Faculty of Social Sciences > Warwick Business School > Finance Group
Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH): Utility theory -- Mathematical models, Finance, Stockholders, Capitalists and financiers, Portfolio management, Investments, Securities
Journal or Publication Title: European Journal of Operational Research
Publisher: Elsevier Science BV
ISSN: 0377-2217
Official Date: 16 February 2018
Dates:
DateEvent
16 February 2018Published
12 August 2017Available
5 August 2017Accepted
Date of first compliant deposit: 10 August 2017
Volume: 265
Number: 1
Page Range: pp. 389-398
DOI: 10.1016/j.ejor.2017.08.010
Status: Peer Reviewed
Publication Status: Published
Access rights to Published version: Restricted or Subscription Access
RIOXX Funder/Project Grant:
Project/Grant IDRIOXX Funder NameFunder ID
RDF-14-02-51Xi’an Jiaotong-Liverpool Universityhttp://dx.doi.org/10.13039/501100006683

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