Portfolio Allocation to Corporate Bonds with Correlated Defaults

CALT Working Paper No. 68-2365

18 Pages Posted: 27 May 2002

See all articles by Mark B. Wise

Mark B. Wise

California Institute of Technology

Vineer Bhansali

LongTail Alpha, LLC

Multiple version iconThere are 2 versions of this paper

Date Written: May 2002

Abstract

This article deals with the problem of optimal allocation of capital to corporate bonds in fixed income portfolios when there is the possibility of correlated defaults. Under fairly general assumptions for the distribution of the total net assets of a set of firms we show that retaining the first few moments of the portfolio default loss distribution gives an extremely good approximation to the full solution of the asset allocation problem. We provide detailed results on the convergence of the moment expansion. We also provide explicit results for the inverse problem, i.e. for a given allocation to the set of risky bonds, what is the average risk premium required to make the portfolio optimal. Numerous numerical illustrations exhibit the results for realistic portfolios and utility functions.

Suggested Citation

Wise, Mark B. and Bhansali, Vineer, Portfolio Allocation to Corporate Bonds with Correlated Defaults (May 2002). CALT Working Paper No. 68-2365. Available at SSRN: https://ssrn.com/abstract=311123 or http://dx.doi.org/10.2139/ssrn.311123

Mark B. Wise (Contact Author)

California Institute of Technology ( email )

Pasadena, CA 91125
United States
626-395-6687 (Phone)
626-568-8473 (Fax)

Vineer Bhansali

LongTail Alpha, LLC ( email )

500 Newport Center Drive
Suite 820
Newport Beach, CA 92660
United States

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