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Portfolio Diversification in the Sovereign Credit Swap Markets

Author

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  • Consiglio, Andrea

    (University of Palermo)

  • Lotfi, Somayyeh

    (University of Guilan)

  • Zenios, Stavros A.

    (University of Cyprus and University of Pennsylvania)

Abstract

We develop models for portfolio diversification in the sovereign credit default swap (CDS) markets and show that, despite literature findings that sovereign CDS spreads are affected by global factors, there is sufficient idiosyncratic risk to be diversified away. However, we identify regime switching in the times series of CDS spreads, and the portfolio diversification strategies may differ between regimes. The models trade of the CVaR risk measure against expected return. They are tested in an active management setting for Eurozone core, periphery, and Central, Eastern and South-Eastern Europe (CESEE) countries. Models are developed for investors with long positions in CDS, speculators that hold uncovered long and short positions, and hedgers with covered long and short exposures. The results compare favorably with the broad S&P/ISDA Eurozone Developed Nation Sovereign CDS index. We also identify several issues that remain unexplored on the way to developing integrated risk management models for CDS portfolios.

Suggested Citation

  • Consiglio, Andrea & Lotfi, Somayyeh & Zenios, Stavros A., 2016. "Portfolio Diversification in the Sovereign Credit Swap Markets," Working Papers 16-06, University of Pennsylvania, Wharton School, Weiss Center.
  • Handle: RePEc:ecl:upafin:16-06
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    1. repec:wsi:ijtafx:v:21:y:2018:i:08:n:s0219024918500498 is not listed on IDEAS
    2. repec:kap:revdev:v:22:y:2019:i:2:d:10.1007_s11147-018-9148-8 is not listed on IDEAS
    3. Andrea Consiglio & Michele Tumminello & Stavros A. Zenios, 2018. "Pricing Sovereign Contingent Convertible Debt," Journal of Enterprising Culture (JEC), World Scientific Publishing Co. Pte. Ltd., vol. 21(08), pages 1-36, December.

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