How to Invest Optimally in Corporate Bonds: A Reduced-Form Approach

Holger Kraft and Mogens Steffensen
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Holger Kraft: Department of Mathematics, University of Kaiserslautern
Mogens Steffensen: Fraunhofer ITWM, Institute for Industrial Mathematics, Department of Finance, Kaiserslautern

No 2005/07, FRU Working Papers from University of Copenhagen. Department of Economics. Finance Research Unit

Abstract: In this paper, we analyze the impact of default risk on the portfolio decision of an investor wishing to invest in corporate bonds. Default risk is modeled via a reduced form approach and we allow for random recovery as well as joint default events. Depending on the structure of the model, we are able to derive almost explicit results for the optimal portfolio strategies. It is demonstrated how these strategies change if common default factors can trigger defaults of more than one bond or different recovery assumptions are imposed. In particular, we analyze the effect of beta distributed loss rates.

Keywords: portfolio optimization; stochastic interest rates; default risk; recovery risk; beta distribution (search for similar items in EconPapers)
JEL-codes: G11 G33 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2005-05
New Economics Papers: this item is included in nep-fin and nep-rmg
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Citations: View citations in EconPapers (2)

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