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How to Invest Optimally in Corporate Bonds: A Reduced-Form Approach

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Author Info

  • Holger Kraft

    (Department of Mathematics, University of Kaiserslautern)

  • Mogens Steffensen

    (Fraunhofer ITWM, Institute for Industrial Mathematics, Department of Finance, Kaiserslautern)

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    Abstract

    In this paper, we analyze the impact of default risk on the portfolio decision of an investor wishing to invest in corporate bonds. Default risk is modeled via a reduced form approach and we allow for random recovery as well as joint default events. Depending on the structure of the model, we are able to derive almost explicit results for the optimal portfolio strategies. It is demonstrated how these strategies change if common default factors can trigger defaults of more than one bond or different recovery assumptions are imposed. In particular, we analyze the effect of beta distributed loss rates.

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    Bibliographic Info

    Paper provided by University of Copenhagen. Department of Economics. Finance Research Unit in its series FRU Working Papers with number 2005/07.

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    Length: 24 pages
    Date of creation: May 2005
    Date of revision:
    Handle: RePEc:kud:kuiefr:200507

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    Related research

    Keywords: portfolio optimization; stochastic interest rates; default risk; recovery risk; beta distribution;

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    Cited by:
    1. Morten Christensen & Eckhard Platen, 2005. "Sharpe Ratio Maximization and Expected Utility when Asset Prices have Jumps," Research Paper Series 170, Quantitative Finance Research Centre, University of Technology, Sydney.

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