Optimal Credit Swap Portfolios

32 Pages Posted: 3 Jul 2009 Last revised: 20 Aug 2018

See all articles by Kay Giesecke

Kay Giesecke

Stanford University - Management Science & Engineering

Baeho Kim

Korea University Business School (KUBS)

Jack Kim

Stanford University - Management Science & Engineering

Gerry Tsoukalas

University of Pennsylvania - The Wharton School

Date Written: December 16, 2013

Abstract

This paper formulates and solves the selection problem for a portfolio of credit swaps. The problem is cast as a goal program that entails a constrained optimization of preference-weighted moments of the portfolio value at the investment horizon. The portfolio value takes account of the exact timing of protection premium and default loss payments, as well as any mark-to-market profits and losses realized at the horizon. The constraints address collateral and solvency requirements, initial capital, position limits, and other trading constraints that credit swap investors often face in practice. The multi-moment formulation accommodates the complex distribution of the portfolio value, which is a nested expectation under risk-neutral and actual probabilities. It also generates computational tractability. Numerical results illustrate the features of optimal portfolios. In particular, we find that credit swap investment constraints can have a significant impact on optimal portfolios, even for simple investment objectives. Our problem formulation and solution approach extend to corporate bond portfolios and mixed portfolios of corporate bonds and credit derivatives.

Keywords: portfolio selection, credit swap, goal program, nested expectation

Suggested Citation

Giesecke, Kay and Kim, Baeho and Kim, Jack and Tsoukalas, Gerry, Optimal Credit Swap Portfolios (December 16, 2013). Available at SSRN: https://ssrn.com/abstract=1427410 or http://dx.doi.org/10.2139/ssrn.1427410

Kay Giesecke (Contact Author)

Stanford University - Management Science & Engineering ( email )

473 Via Ortega
Stanford, CA 94305-9025
United States
(650) 723 9265 (Phone)
(650) 723 1614 (Fax)

HOME PAGE: http://www.stanford.edu/~giesecke/

Baeho Kim

Korea University Business School (KUBS) ( email )

Anam-dong, Sungbuk-Gu
Korea University Business School
Seoul, 136-701
82-2-3290-2626 (Phone)
82-2-922-7220 (Fax)

HOME PAGE: http://biz.korea.ac.kr/~baehokim

Jack Kim

Stanford University - Management Science & Engineering ( email )

473 Via Ortega
Stanford, CA 94305-9025
United States

Gerry Tsoukalas

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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