Portfolio Diversification in the Sovereign Credit Swap Markets

Andrea Consiglio, Somayyeh Lotfi and Stavros Zenios
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Andrea Consiglio: University of Palermo
Somayyeh Lotfi: University of Guilan

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: We develop models for portfolio diversification in the sovereign credit default swap (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 away. However, we identify regime switching in the times series of CDS spreads, and the portfolio diversification strategies may differ between regimes. The models trade of the CVaR risk measure against expected return. They are tested in an active management setting for Eurozone core, periphery, and Central, Eastern and South-Eastern Europe (CESEE) countries. Models are developed for investors with long positions in CDS, speculators that hold uncovered long and short positions, and hedgers with covered long and short exposures. The results compare favorably with the broad S&P/ISDA Eurozone Developed Nation Sovereign CDS index. We also identify several issues that remain unexplored on the way to developing integrated risk management models for CDS portfolios.

Date: 2016-07
New Economics Papers: this item is included in nep-eec and nep-fmk
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Related works:
Journal Article: Portfolio diversification in the sovereign credit swap markets (2018)
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