Portfolio optimization with insider's initial information and counterparty risk
We study the gain of an insider having private information which concerns the default risk of a counterparty. More precisely, the default time \tau is modelled as the first time a stochastic process hits a random barrier L. The insider knows this barrier (as it can be the case for example for the manager of the counterparty), whereas standard investors only observe its value at the default time. All investors aim to maximize the expected utility from terminal wealth, on a financial market where the risky asset price is exposed to a sudden loss at the default time of the counterparty. In this framework, the insider's information is modelled by using an initial enlargement of filtration and \tau is a stopping time with respect to this enlarged filtration. We prove that the regulator must impose short selling constraints for the insider, in order to exclude the value process to reach infinity. We then solve the optimization problem and we study the gain of the insider, theoretically and numerically. In general, the insider achieves a larger value of expected utility than the standard investor. But in extreme situations for the default and loss risks, a standard investor may in average outperform the insider, by taking advantage of an aggressive short selling position which is not allowed for the insider, but at the risk of big losses if the default finally occurs after the maturity.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1208.5398. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
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.