Robust Optimization of Credit Portfolios

Mathematics of Operations Research, Forthcoming

29 Pages Posted: 18 Jan 2016

See all articles by Lijun Bo

Lijun Bo

University of Science and Technology of China (USTC)

Agostino Capponi

Columbia University - Department of Industrial Engineering and Operations Research

Date Written: January 16, 2016

Abstract

We introduce a dynamic credit portfolio framework where optimal investment strategies are robust against misspecifications of the reference credit model. The risk-averse investor models his fear of credit risk misspecification by considering a set of plausible alternatives whose expected log likelihood ratios are penalized. We provide an explicit characterization of the optimal robust bond investment strategy, in terms of default state dependent value functions associated with the max-min robust optimization criterion. The value functions can be obtained as the solutions of a recursive system of HJB equations. We show that each HJB equation is equivalent to a suitably truncated equation admitting a unique bounded regular solution. The truncation technique relies on estimates for the solution of the master HJB equation that we establish.

Suggested Citation

Bo, Lijun and Capponi, Agostino, Robust Optimization of Credit Portfolios (January 16, 2016). Mathematics of Operations Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2716772

Lijun Bo

University of Science and Technology of China (USTC) ( email )

96, Jinzhai Road
Hefei, Anhui 230026
China

Agostino Capponi (Contact Author)

Columbia University - Department of Industrial Engineering and Operations Research ( email )

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