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Asset allocation with contagion and explicit bankruptcy procedures

  • Kraft, Holger
  • Steffensen, Mogens
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    In 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%.

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    Article provided by Elsevier in its journal Journal of Mathematical Economics.

    Volume (Year): 45 (2009)
    Issue (Month): 1-2 (January)
    Pages: 147-167

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    Handle: RePEc:eee:mateco:v:45:y:2009:i:1-2:p:147-167
    Contact details of provider: Web page: http://www.elsevier.com/locate/jmateco

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