The effects of systemic crises when investors can be crisis ignorant
2004-04-17
Research Paper
| Related Files |
|---|
View PDF Version
(ERS 2004 027 F&A.pdf, 0.8MB) |
Systemic crises can largely affect asset allocations due to the rapid deterioration of the risk-return trade-off. We investigate the effects of systemic crises, interpreted as global simultaneous shocks to financial markets, by introducing an investor adopting a crisis ignorant or crisis conscious strategy. Including the possibility of a systemic crisis is a substantial improvement. Investments in risky assets fall, while allocations to countries less sensitive to a crisis grow relatively. An increasing probability of a crisis exacerbates these effects. The certainty equivalent costs of ignoring systemic crises are large, ranging from 0.65% per year unconditionally, to over 5% per month conditionally on a high probability for the occurrence of a crisis.
- C51 : Model Construction and Estimation
- G3 : Corporate Finance and Governance
- M : Business Administration and Business Economics; Marketing; Accounting
- M41 : Accounting
- G11 : Portfolio Choice; Investment Decisions
- G15 : International Financial Markets
- G01 : Financial Crises
- F30 : International Finance: General
- crisis
- regime
- strategy
- effect
- asset
- probability
- return
- state
- market
- allocation
- portfolio
- model
- investor
- crisis regime
- volatility
- vector
- difference
- crisis effect
- asset allocation
- variance
