Asset allocation with contagion and explicit bankruptcy procedures
AbstractIn this paper, we consider the asset allocation problem of an investor allocating his funds between several corporate bonds and a money market account. In particular, we provide a realistic model of financial distress: firstly, we model Chapter 7 and Chapter 11 bankruptcies as different possible outcomes of financial distress. Secondly, we take into consideration that, in practice, "default" is not the end, but the beginning of financial distress, eventually leading to a reorganization or a liquidation of a distressed firm. Thirdly and most importantly, we are able to analyze the impact of contagion on an investor's demand for corporate bonds. Contagion is an important phenomenon, as it reduces the investor's ability to diversify his portfolio, and we show that the bond demand can change by more than 50%.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Elsevier in its journal Journal of Mathematical Economics.
Volume (Year): 45 (2009)
Issue (Month): 1-2 (January)
Contact details of provider:
Web page: http://www.elsevier.com/locate/jmateco
Portfolio optimization Liquidation Reorganization Default Finite state Markov chain;
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Brennan, Michael J. & Schwartz, Eduardo S. & Lagnado, Ronald, 1997. "Strategic asset allocation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 21(8-9), pages 1377-1403, June.
- Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 50(1), pages 53-85, March.
- Longstaff, Francis A, 2001. "Optimal Portfolio Choice and the Valuation of Illiquid Securities," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 14(2), pages 407-31.
- Jun Liu & Francis A. Longstaff & Jun Pan, 2003.
"Dynamic Asset Allocation with Event Risk,"
Journal of Finance, American Finance Association,
American Finance Association, vol. 58(1), pages 231-259, 02.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Robert A. Jarrow & David Lando & Fan Yu, 2005. "Default Risk And Diversification: Theory And Empirical Implications," Mathematical Finance, Wiley Blackwell, Wiley Blackwell, vol. 15(1), pages 1-26.
- Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
- Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, Elsevier, vol. 20(3), pages 381-408, June.
- Dirk Becherer & Martin Schweizer, 2005. "Classical solutions to reaction-diffusion systems for hedging problems with interacting Ito and point processes," Papers math/0505208, arXiv.org.
- Fan Yu, 2007. "Correlated Defaults In Intensity-Based Models," Mathematical Finance, Wiley Blackwell, Wiley Blackwell, vol. 17(2), pages 155-173.
- Kraft, Holger & Steffensen, Mogens, 2008. "How to invest optimally in corporate bonds: A reduced-form approach," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(2), pages 348-385, February.
- Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
- Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
- Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, American Finance Association, vol. 56(4), pages 1401-1440, 08.
- Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, American Finance Association, vol. 56(5), pages 1765-1799, October.
- Sørensen, Carsten, 1999. "Dynamic Asset Allocation and Fixed Income Management," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 34(04), pages 513-531, December.
- Branger, Nicole & Kraft, Holger & Meinerding, Christoph, 2009. "What is the impact of stock market contagion on an investor's portfolio choice?," Insurance: Mathematics and Economics, Elsevier, vol. 45(1), pages 94-112, August.
- Branger, Nicole & Kraft, Holger & Meinerding, Christoph, 2014. "Partial information about contagion risk, self-exciting processes and portfolio optimization," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 39(C), pages 18-36.
- Konermann, Patrick & Meinerding, Christoph & Sedova, Olga, 2013. "Asset allocation in markets with contagion: The interplay between volatilities, jump intensities, and correlations," Review of Financial Economics, Elsevier, Elsevier, vol. 22(1), pages 36-46.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.