Scenario-based dynamic corporate bond portfolio management

The 2008 credit crisis has deeply affected the price of corporate liabilities in both equity and fixed income secondary markets leading to unprecedented portfolio losses by financial investors. A coordinated intervention by monetary institutions limited the systemic consequences of the crisis, without, however, avoiding a significant fall of corporate bond prices across international markets. In this article, we analyse alternative portfolio optimization approaches in the fixed income market over the 2008‐2009 period, a time in which credit derivative markets became very illiquid. All policies are analysed relying on a unique set of market and credit scenarios generated by common and idiosyncratic risk factors on an extended investment universe. The crisis provides an interesting test period to analyse in particular the potential of dynamic versus static portfolio selection approaches. We also consider dynamic portfolio strategies based on multistage stochastic programming versus policy rule-based methods and analyse their relative performance against a corporate bond index widely adopted in practice as a market benchmark.

[1]  M. Crouhy,et al.  A comparative analysis of current credit risk models , 2000 .

[2]  Ronald Hochreiter,et al.  Financial scenario generation for stochastic multi-stage decision processes as facility location problems , 2007, Ann. Oper. Res..

[3]  Helmut Mausser,et al.  Credit risk optimization with Conditional Value-at-Risk criterion , 2001, Math. Program..

[4]  D. Duffie,et al.  Modeling term structures of defaultable bonds , 1999 .

[5]  M. Dempster.  On stochastic programming. II: Dynamic problems under risk , 1988 .

[6]  John M. Mulvey,et al.  An Asset and Liability Management System for Towers Perrin-Tillinghast , 2000, Interfaces.

[7]  S. Bradley,et al.  A Dynamic Model for Bond Portfolio Management , 1972 .

[8]  M. Dempster,et al.  Global Asset Liability Management , 2003, British Actuarial Journal.

[9]  Vittorio Moriggia,et al.  Bond portfolio management via stochastic programming , 2008 .

[10]  Gautam Mitra,et al.  Integrating market and credit risk: A simulation and optimisation perspective , 2006 .

[11]  Michael A. H. Dempster,et al.  Dynamic Stochastic Programming for Asset-Liability Management , 1998 .

[12]  G. Pflug,et al.  Modeling, Measuring and Managing Risk , 2008 .

[13]  Darrell Duffie,et al.  Measuring Default Risk Premia from Default Swap Rates and EDFs , 2007 .

[14]  Stavros A. Zenios,et al.  On the simulation of portfolios of interest rate and credit risk sensitive securities , 2005, Eur. J. Oper. Res..

[15]  John R. Birge,et al.  Introduction to Stochastic Programming , 1997 .

[16]  Peter Tufano,et al.  Pricing Credit-Sensitive Debt When Interest Rates, Credit Ratings and Credit Spreads Are Stochastic , 1997 .

[17]  D. Duffie,et al.  Transform Analysis and Asset Pricing for Affine Jump-Diffusions , 1999 .

[18]  E. Elton,et al.  Explaining the Rate Spread on Corporate Bonds , 1999 .

[19]  S. Zenios,et al.  Handbook of asset and liability management: applications and case studies , 2007 .

[20]  Werner Römisch,et al.  Scenario Reduction Algorithms in Stochastic Programming , 2003, Comput. Optim. Appl..

[21]  Stavros A. Zenios,et al.  Asset/liability management under uncertainty for fixed-income securities , 1995, Ann. Oper. Res..

[22]  A. Lo,et al.  THE ECONOMETRICS OF FINANCIAL MARKETS , 1996, Macroeconomic Dynamics.

[23]  Robert A. Jarrow,et al.  The intersection of market and credit risk , 2000 .

[24]  Jitka Dupacová,et al.  Scenarios for Multistage Stochastic Programs , 2000, Ann. Oper. Res..

[25]  Stanislav Uryasev,et al.  Conditional Value-at-Risk for General Loss Distributions , 2002 .

[26]  G. Consigli,et al.  Path-dependent scenario trees for multistage stochastic programmes in finance , 2012 .

[27]  Pricing nondiversifiable credit risk in the corporate Eurobond market , 2007 .

[28]  K. Singleton,et al.  Term Structure Dynamics in Theory and Reality , 2002 .