Reaching nirvana with a defaultable asset?

Anna Battauz (), Marzia De Donno and Alessandro Sbuelz ()
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Anna Battauz: Bocconi University
Alessandro Sbuelz: Catholic University of Milan

Decisions in Economics and Finance, 2017, vol. 40, issue 1, No 2, 52 pages

Abstract: Abstract We study the optimal dynamic portfolio exposure to predictable default risk, taking inspiration from the search for yield by means of defaultable assets observed before the 2007–2008 crisis and in its aftermath. Under no arbitrage, default risk is compensated by an ‘yield pickup’ that can strongly attract aggressive investors via an investment-horizon effect in their optimal non-myopic portfolios. We show it by stating the optimal dynamic portfolio problem of Kim and Omberg (Rev Financ Stud 9:141–161, 1996) for a defaultable risky asset and by rigorously proving the existence of nirvana-type solutions. We achieve such a contribution to the portfolio optimization literature by means of a careful, closed-form-yielding adaptation to our defaultable asset setting of the general convex duality approach of Kramkov and Schachermayer (Ann Appl Probab 9(3):904–950, 1999; Ann Appl Probab 13(4):1504–1516, 2003).

Keywords: Dynamic asset allocation; Duality-based optimal portfolio solutions; Convex duality; Non-myopic speculation; Leverage; Investment horizon; Sharpe ratio risk; Reaching for yield; Predictable default risk (search for similar items in EconPapers)
JEL-codes: C61 D84 D90 G01 G10 G11 G12 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s10203-017-0192-x

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