 Portfolio credit-risk optimizationIan Iscoe, Alexander Kreinin, Helmut Mausser and Oleksandr Romanko Journal of Banking & Finance, 2012, vol. 36, issue 6, 1604-1615 Abstract: This paper evaluates several alternative formulations for minimizing the credit risk of a portfolio of financial contracts with different counterparties. Credit risk optimization is challenging because the portfolio loss distribution is typically unavailable in closed form. This makes it difficult to accurately compute Value-at-Risk (VaR) and expected shortfall (ES) at the extreme quantiles that are of practical interest to financial institutions. Our formulations all exploit the conditional independence of counterparties under a structural credit risk model. We consider various approximations to the conditional portfolio loss distribution and formulate VaR and ES minimization problems for each case. We use two realistic credit portfolios to assess the in- and out-of-sample performance for the resulting VaR- and ES-optimized portfolios, as well as for those which we obtain by minimizing the variance or the second moment of the portfolio losses. We find that a Normal approximation to the conditional loss distribution performs best from a practical standpoint. Keywords: Credit risk; Optimization; Portfolio optimization; Risk modeling; Value-at-Risk; Expected shortfall (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:6:p:1604-1615 DOI: 10.1016/j.jbankfin.2012.01.013 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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