Reaching Nirvana with a Defaultable Asset?

36 Pages Posted: 31 Mar 2011

See all articles by Alessandro Sbuelz

Alessandro Sbuelz

Catholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics; Bocconi University - CAREFIN - Centre for Applied Research in Finance

Anna Battauz

Bocconi University - Department of Finance

Date Written: June 1, 2010

Abstract

We contribute a new insight into the pre-crisis massive levered exposures to default risk by formulating a parsimonious, closed-form analysis of conspicuous risk taking in default-prone assets. 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 that default risk decoupled from event risk does not discourage the formation of markedly geared portfolios. Our results add a new portfolio-based perspective to a mainstream model of default risk: even if arbitrage-free, the model may not find unconstrained support in general equilibrium.

Keywords: dynamic asset allocation, defaultable asset, Sharpe-ratio uncertainty, levered non-myopic speculation, the Constant Elasticity of Variance (CEV) model

JEL Classification: G11, G12, C61

Suggested Citation

Sbuelz, Alessandro and Battauz, Anna, Reaching Nirvana with a Defaultable Asset? (June 1, 2010). CAREFIN Research Paper No. 11/2010, Available at SSRN: https://ssrn.com/abstract=1798636

Alessandro Sbuelz (Contact Author)

Catholic University of Milan - Department of Mathematics, Quantitative Finance, and Econometrics ( email )

largo A. Gemelli 1
I-20123 Milan
Italy
+39 02 7234 2345 (Phone)
+39 02 7234 2671 (Fax)

HOME PAGE: http://ppd.unicatt.it/docenti/alessandro_sbuelz

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Via Sarfatti, 25
Milan, 20136
Italy

Anna Battauz

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

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