Jumps and Dynamic Portfolio Decisions

Abstract

A central feature of the asset return data is non-normality, which raises important questions about asset allocation. This paper provides a general framework for analyzing optimal dynamic asset allocation problems in economies with infrequent events and where the investment opportunities are stochastic and predictable. Analytical solutions are obtained, from which we are able to do a thorough comparative study of the impacts of jumps. We also calibrate the model to the U.S. equity market and find that jump risk substantially reduces the investor's demand for stocks.