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Portfolio Allocation Subject to Credit Risk

Author

Listed:
  • Rogerio de Deus Oliveira

    (JP Morgan)

  • Caio Ibsen Rodrgues de Almeida

    (Ibmec RJ e Mathematics Dept, Stanford University)

Abstract

Credit Risk is an important dimension to be considered in the risk management procedures of financial institutions. Is a particularly useful in emerging markets where default rates on bank loan products are usually high. It is usually calculated through highly costly Monte Carlo simulations which consider different stochastic factors driving the uncertainly associated to the borrowers liabilities. In this paper, under some restrictions, we drive closed form formulas for the probability distributions of default rates of bank loans products involving a big number of clients. This allows us to quickly obtain the credit risk of such products. Moreover, using these probability distributions, we solve the problem of optimal portfolio allocation under default risk.

Suggested Citation

  • Rogerio de Deus Oliveira & Caio Ibsen Rodrgues de Almeida, 2003. "Portfolio Allocation Subject to Credit Risk," Brazilian Review of Finance, Brazilian Society of Finance, vol. 1(2), pages 301-339.
    • Handle: RePEc:brf:journl:v:1:y:2003:i:2:p:301-339
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    More about this item

    Keywords

    default; credit risk; probability distribution; asset alocation; total return; maximum loss; value at risk;
    All these keywords.

    JEL classification:

    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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