Credit Portfolio Selection with Decaying Contagion Intensities

37 Pages Posted: 11 Jan 2019

See all articles by Lijun Bo

Lijun Bo

University of Science and Technology of China (USTC)

Agostino Capponi

Columbia University

Peng‐Chu Chen

The University of Hong Kong

Multiple version iconThere are 2 versions of this paper

Date Written: January 2019

Abstract

We develop a fixed‐income portfolio framework capturing the exponential decay of contagious intensities between successive default events. We show that the value function of the control problem is the classical solution to a recursive system of second‐order uniformly parabolic Hamilton–Jacobi–Bellman partial differential equations. We analyze the interplay between risk premia, decay of default intensities, and their volatilities. Our comparative statics analysis finds that the investor chooses to go long only if he is capturing enough risk premia. If the default intensities deteriorate faster, the investor increases the size of his position if he goes short, or reduces the size of his position if he goes long.

Keywords: decay of default intensities, dynamic programming, fixed‐income investment, parabolic PDEs

Suggested Citation

Bo, Lijun and Capponi, Agostino and Chen, Peng‐Chu, Credit Portfolio Selection with Decaying Contagion Intensities (January 2019). Mathematical Finance, Vol. 29, Issue 1, pp. 137-173, 2019. Available at SSRN: https://ssrn.com/abstract=3313659 or http://dx.doi.org/10.1111/mafi.12177

Lijun Bo (Contact Author)

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

96, Jinzhai Road
Hefei, Anhui 230026
China

Agostino Capponi

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Peng‐Chu Chen

The University of Hong Kong

Pokfulam Road
Hong Kong, HK
China

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