The Effect of Asset Price Jumps on Consumption and Investment Decisions

Abstract

This paper examines the importance of jumps in asset prices for investment problems potentially incorporating consumption decisions. We present a technique for solving investment-consumption problems when asset prices jump. We also demonstrate how to quantify utility losses using an "optimal fee" approach - measuring how much a portfolio advisor could charge an investor to provide them with the new investment technology. As an application we consider empirically plausible models for the S&P 500 index. We conclude that while there are some moderate differences in optimal investment behaviour once jumps are accounted for the actual utility loss in economic terms is very low.