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.

asset allocation, international finance, regime switching, systemic risk
Model Construction and Estimation (jel C51), International Finance: General (jel F30), Financial Crises (jel G01), Portfolio Choice; Investment Decisions (jel G11), International Financial Markets (jel G15), Corporate Finance and Governance (jel G3), Business Administration and Business Economics; Marketing; Accounting (jel M), Accounting (jel M41)
ERIM Report Series Research in Management
Erasmus Research Institute of Management

Kole, H.J.W.G, Koedijk, C.G, & Verbeek, M.J.C.M. (2004). The effects of systemic crises when investors can be crisis ignorant (No. ERS-2004-027-F&A). ERIM Report Series Research in Management. Retrieved from