Systemic Risk and International Portfolio Choice SANJIV RANJAN DAS and RAMAN UPPAL∗

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 opti-mal 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 posi-tions. We find that the loss resulting from diminished diversification is small, while that from holding very highly levered positions is large. RETURNS ON INTERNATIONAL EQUITIES are characterized by jumps;1 moreover, these jumps tend to occur at the same time across countries, implying that conditional correlations between international equity returns tend to be higher in periods of high market volatility or following large downside moves.2 Our objective i