We consider the problem of optimal investment and consumption in a class of multidimensional jump-diffusion models in which asset prices are subject to mutually exciting jump processes. This captures a type of contagion where each downward jump in an asset's price results in increased likelihood of further jumps, both in that asset and in the other assets.We solve in closed-form the dynamic consumption-investment problem of a log-utility investor in such a contagion model, prove its optimality and discuss features of the solution, including flight-toquality. The clustering of jumps gives rise to a time-varying optimal asset allocation: as jumps predict more jumps, the portfolio should be optimally rebalanced to hedge the risk of future jumps. The exponential and power utility investors are also considered: in these cases, the optimal strategy can be characterized as a distortion of the strategy of a corresponding non-contagion investor.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics
- Hawkes process
- Merton problem
- Mutual excitation