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Credit portfolio selection with decaying contagion intensities

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  • Lijun Bo
  • Agostino Capponi
  • Peng‐Chu Chen

Abstract

We develop a fixed‐income portfolio framework capturing the exponential decay of contagious intensities between successive default events. We show that the value function of the control problem is the classical solution to a recursive system of second‐order uniformly parabolic Hamilton–Jacobi–Bellman partial differential equations. We analyze the interplay between risk premia, decay of default intensities, and their volatilities. Our comparative statics analysis finds that the investor chooses to go long only if he is capturing enough risk premia. If the default intensities deteriorate faster, the investor increases the size of his position if he goes short, or reduces the size of his position if he goes long.

Suggested Citation

  • Lijun Bo & Agostino Capponi & Peng‐Chu Chen, 2019. "Credit portfolio selection with decaying contagion intensities," Mathematical Finance, Wiley Blackwell, vol. 29(1), pages 137-173, January.
  • Handle: RePEc:bla:mathfi:v:29:y:2019:i:1:p:137-173
    DOI: 10.1111/mafi.12177
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    Cited by:

    1. F. Antonelli & A. Ramponi & S. Scarlatti, 2021. "CVA and vulnerable options pricing by correlation expansions," Annals of Operations Research, Springer, vol. 299(1), pages 401-427, April.
    2. Zhuo Jin & Huafu Liao & Yue Yang & Xiang Yu, 2019. "Optimal Dividend Strategy for an Insurance Group with Contagious Default Risk," Papers 1909.09511, arXiv.org, revised Oct 2020.
    3. Yang Shen & Bin Zou, 2021. "Mean-Variance Portfolio Selection in Contagious Markets," Papers 2110.09417, arXiv.org.
    4. Lorig, Matthew & Zhou, Zhou & Zou, Bin, 2021. "Optimal bookmaking," European Journal of Operational Research, Elsevier, vol. 295(2), pages 560-574.
    5. Antonelli, Fabio & Ramponi, Alessandro & Scarlatti, Sergio, 2022. "Approximate value adjustments for European claims," European Journal of Operational Research, Elsevier, vol. 300(3), pages 1149-1161.
    6. Lijun Bo & Shihua Wang & Xiang Yu, 2021. "Mean Field Game of Optimal Relative Investment with Jump Risk," Papers 2108.00799, arXiv.org, revised Feb 2023.
    7. Fabio Antonelli & Alessandro Ramponi & Sergio Scarlatti, 2020. "Approximate XVA for European claims," Papers 2007.07701, arXiv.org.

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