Economics at your fingertips  

Portfolio credit-risk optimization

Ian 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)
JEL-codes: C02 C61 C63 D81 G11 G32 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (3) Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Series data maintained by Dana Niculescu ().

Page updated 2017-09-29
Handle: RePEc:eee:jbfina:v:36:y:2012:i:6:p:1604-1615