Systemic Risk and International Portfolio Choice




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    • Sanjiv Ranjan Das and Raman Uppal are with Santa Clara University, and CEPR and London Business School, respectively. We are grateful to Stephen Lynagh for excellent research assistance. We thank an anonymous referee, Andrew Ang, Pierluigi Balduzzi, Suleyman Basak, Greg Bauer, Geert Bekaert, Harjoat Bhamra, Michael Brandt, John Campbell, George Chacko, João Cocco, Glen Donaldson, Darrell Duffie, Bernard Dumas, Ken Froot, Francisco Gomes, Eric Jacquier, Tim Johnson, Andrew Karolyi, Andrew Lo, Michelle Lee, Jan Mahrt-Smith, Scott Mayfield, Narayan Naik, Vasant Naik, Roberto Rigobon, Geert Rouwenhorst, Piet Sercu, Milind Shrikhande, Rob Stambaugh, Raghu Sundaram, Luis Viceira, Jiang Wang, Tan Wang, Greg Willard, Wei Xiong, and Hongjun Yan for their suggestions. We also gratefully acknowledge comments from seminar participants at Bank of England, Boston College, Erasmus University, HEC Paris, London Business School, Maryland University, MIT, Swiss National Bank, University of Essex, University of Exeter, University of Maryland, University of Rochester, the 1999 Global Derivatives Conference, VIIth International Conference on Stochastic Programming, International Finance Conference at Georgia Institute of Technology, Conference of International Association of Financial Engineers, NBER Finance Lunch Seminar Series, the 1999 meetings of the European Finance Association, the 2001 meetings of the Western Finance Association, the 2002 meetings of INQUIRE, the 2003 meetings of the American Finance Association, and the 2003 CIRANO Conference on Portfolio Choice.


Returns on international equities are characterized by jumps; moreover, these jumps tend to occur at the same time across countries leading to systemic risk. We capture these stylized facts using a multivariate system of jump-diffusion processes where the arrival of jumps is simultaneous across assets. We then determine an investor's optimal portfolio for this model of returns. Systemic risk has two effects: One, it reduces the gains from diversification and two, it penalizes investors for holding levered positions. We find that the loss resulting from diminished diversification is small, while that from holding very highly levered positions is large.