Portfolio diversification in the sovereign credit swap markets

Andrea Consiglio (), Somayyeh Lotfi () and Stavros Zenios
Additional contact information
Somayyeh Lotfi: University of Cyprus

Annals of Operations Research, 2018, vol. 266, issue 1, No 2, 5-33

Abstract: Abstract We develop models for portfolio diversification in the sovereign credit default swaps (CDS) markets and show that, despite literature findings that sovereign CDS spreads are affected by global factors, there is sufficient idiosyncratic risk to be diversified. However, we identify regime switching in the times series of CDS spreads and spread returns, and the optimal diversified strategies can be regime dependent. The developed models trade off the CVaR risk measure against expected return, consistently with the statistical properties of spreads. We consider three investment strategies suited for different CDS market participants: for investors with long positions, speculators that hold uncovered long and short positions, and hedgers with covered long and short exposures. We use the models to illustrate that diversification pays in the CDS market. The models are also tested for active portfolio management in Eurozone core and periphery, and Central, Eastern and South-Eastern Europe countries, and the optimized portfolio results outperform the broad S&P/ISDA Eurozone Developed Nation Sovereign CDS index. The paper concludes by identifying open questions in developing integrated enterprise-wide risk management models using CDS.

Keywords: Credit derivatives; Portfolio diversification; Eurozone crisis; CDS spreads; Conditional Value-at-Risk; Regime switching (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://link.springer.com/10.1007/s10479-017-2565-5 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
Working Paper: Portfolio Diversification in the Sovereign Credit Swap Markets (2016)
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: https://EconPapers.repec.org/RePEc:spr:annopr:v:266:y:2018:i:1:d:10.1007_s10479-017-2565-5

Ordering information: This journal article can be ordered from
http://www.springer.com/journal/10479

DOI: 10.1007/s10479-017-2565-5

Access Statistics for this article

Annals of Operations Research is currently edited by Endre Boros

More articles in Annals of Operations Research from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().