How to Invest Optimally in Corporate Bonds: A Reduced-Form Approach
AbstractIn 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 InfoPaper provided by University of Copenhagen. Department of Economics. Finance Research Unit in its series FRU Working Papers with number 2005/07.
Length: 24 pages
Date of creation: May 2005
Date of revision:
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portfolio optimization; stochastic interest rates; default risk; recovery risk; beta distribution;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-07-03 (All new papers)
- NEP-FIN-2005-07-03 (Finance)
- NEP-RMG-2005-07-03 (Risk Management)
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- Morten Mosegaard Christensen & Eckhard Platen, 2007.
"Sharpe Ratio Maximization And Expected Utility When Asset Prices Have Jumps,"
International Journal of Theoretical and Applied Finance (IJTAF),
World Scientific Publishing Co. Pte. Ltd., vol. 10(08), pages 1339-1364.
- 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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