Portfolio optimization under credit risk

Portfolio optimization under credit risk

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Article ID: iaor20041929
Country: Germany
Volume: 18
Issue: 3
Start Page Number: 317
End Page Number: 338
Publication Date: Jul 2003
Journal: Computational Statistics
Authors: , ,
Keywords: credit management, portfolio management
Abstract:

Based on the models of Hull & White for the pricing of non-defaultable bonds and Schmid & Zagst for the pricing of defaultable bonds we develop a framework for the optimal allocation of assets out of a universe of sovereign bonds with different time to maturity and quality of the issuer. We estimate the model parameters by applying Kalman filtering methods. Based on these estimates we simulate the prices for a given set of bonds for a future time horizon. For each future time step and for each given portfolio composition these scenarios yield distributions of future cash flows and portfolio values. We show how the portfolio composition can be optimized by maximizing the expected final value or return of the portfolio under given constraints.

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