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Multivariate Jump Diffusion Model with Markovian Contagion

Author

Listed:
  • Pablo Jose Campos de Carvalho
  • Aparna Gupta
Abstract
Asset prices exhibit significant deviation from log-normality, with time-varying stochastics and ample evidence of jumps transmitting from one asset or market to another. We propose a multivariate jump diffusion model with Markovian contagion to capture these asset price dynamics, where the contagion channel periodically switches from an active to an inactive state. Using a dynamic conditional correlation network approach to estimate the Markovian contagion model, we apply the model to an inter-national equity and currency portfolio allocation. The fat tail characteristics captured help evaluate the extent of model risk, intra-asset class, inter-asset and inter-region contagion.

Suggested Citation

  • Pablo Jose Campos de Carvalho & Aparna Gupta, 2018. "Multivariate Jump Diffusion Model with Markovian Contagion," Working Papers Series 482, Central Bank of Brazil, Research Department.
    • Handle: RePEc:bcb:wpaper:482
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    File URL: https://www.bcb.gov.br/content/publicacoes/WorkingPaperSeries/wps482.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. de Carvalho, Pablo Jose Campos & Gupta, Aparna, 2018. "A network approach to unravel asset price comovement using minimal dependence structure," Journal of Banking & Finance, Elsevier, vol. 91(C), pages 119-132.

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