Faculty of Economics and Business Administration Publications Database

How to Invest Optimally in Corporate Bonds

Steffensen, Mogens
Volume: 32
Number: 2
Pages: 348 - 385
Month: February
ISSN-Print: 0165-1889
Link External Source: Online Version
Year: 2008
Keywords: Portfolio optimization; stochastic interest rates; Default risk; Recovery risk; Beta distribution; Joint default factor
Abstract: In this paper, we analyze the impact of default risk on the portfolio decision of an investor wishing to invest in corporate bonds. Default risk is modeled via a reduced-form approach and we allow for random recovery as well as joint default events. Depending on the structure of the model, we are able to derive almost explicit results for the optimal portfolio strategies. It is demonstrated how these strategies change if common default factors can trigger defaults of more than one bond or recovery rates are stochastic. In particular, we analyze the effect of beta distributed loss rates.