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Credit risk diversification: evidence from the eurobond market

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  • Simone Varotto

Abstract

This paper studies the role of diversification in reducing the volatility of corporate bond returns induced by changes in credit spreads. Specifically, it looks at how credit risk can be diminished when a portfolio is diversified across countries, industry sectors, maturities, seniority types and credit ratings. The role of national industrial structures for international diversification is also investigated. The results suggest that geographical diversification is more effective in reducing portfolio risk than alternative investment strategies considered, and that industry effects are not material to this result. Finally, the paper explores the implications of these findings for credit risk capital regulation in banks.

Suggested Citation

  • Simone Varotto, 2003. "Credit risk diversification: evidence from the eurobond market," Bank of England working papers 199, Bank of England.
  • Handle: RePEc:boe:boeewp:199
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    File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2003/wp199.pdf
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    Cited by:

    1. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer;Western Finance Association, vol. 26(2), pages 161-191, October.
    2. Pieterse-Bloem, M., 2011. "The effect of Emu on bond market integration and investor portfolio allocations," Other publications TiSEM 3c6ce80d-9260-424a-b889-b, Tilburg University, School of Economics and Management.
    3. Heidorn, Thomas & Buschmann, Christian, 2014. "The liquidity reserve funding and management strategies," Frankfurt School - Working Paper Series 210, Frankfurt School of Finance and Management.
    4. Carlos Castro, 2010. "Portfolio choice under local industry and country factors," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 24(4), pages 353-393, December.
    5. Pieterse-Bloem, Mary & Qian, Zhaowen & Verschoor, Willem & Zwinkels, Remco, 2016. "Time-varying importance of country and industry factors in European corporate bonds," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 429-448.
    6. Pieterse-Bloem, Mary & Mahieu, Ronald J., 2013. "Factor decomposition and diversification in European corporate bond markets," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 194-213.

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