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Reaching nirvana with a defaultable asset?

Author

Listed:
  • Anna Battauz

    () (Bocconi University)

  • Marzia Donno

    () (University of Parma)

  • Alessandro Sbuelz

    () (Catholic University of Milan)

Abstract

Abstract We study the optimal dynamic portfolio exposure to predictable default risk, taking inspiration from the search for yield by means of defaultable assets observed before the 2007–2008 crisis and in its aftermath. Under no arbitrage, default risk is compensated by an ‘yield pickup’ that can strongly attract aggressive investors via an investment-horizon effect in their optimal non-myopic portfolios. We show it by stating the optimal dynamic portfolio problem of Kim and Omberg (Rev Financ Stud 9:141–161, 1996) for a defaultable risky asset and by rigorously proving the existence of nirvana-type solutions. We achieve such a contribution to the portfolio optimization literature by means of a careful, closed-form-yielding adaptation to our defaultable asset setting of the general convex duality approach of Kramkov and Schachermayer (Ann Appl Probab 9(3):904–950, 1999; Ann Appl Probab 13(4):1504–1516, 2003).

Suggested Citation

  • Anna Battauz & Marzia Donno & Alessandro Sbuelz, 2017. "Reaching nirvana with a defaultable asset?," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 40(1), pages 31-52, November.
  • Handle: RePEc:spr:decfin:v:40:y:2017:i:1:d:10.1007_s10203-017-0192-x
    DOI: 10.1007/s10203-017-0192-x
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    References listed on IDEAS

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    More about this item

    Keywords

    Dynamic asset allocation; Duality-based optimal portfolio solutions; Convex duality; Non-myopic speculation; Leverage; Investment horizon; Sharpe ratio risk; Reaching for yield; Predictable default risk;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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