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Optimal Credit Allocation Under Regime Uncertainty With Sensitivity Analysis

Author

Listed:
  • GUILLAUME BERNIS

    (Natixis Asset Management, Fixed Income, Paris, France)

  • LAURENCE CARASSUS

    (LMR (EA 4535), Université Reims Champagne Ardenne, Reims, France)

  • GRÉGOIRE DOCQ

    (Natixis Asset Management, Fixed Income, Paris, France)

  • SIMONE SCOTTI

    (LPMA, Université Paris Diderot, Paris, France)

Abstract

We consider the problem of credit allocation in a regime-switching model. The global evolution of the credit market is driven by a benchmark, the drift of which is given by a two-state continuous-time hidden Markov chain. We apply filtering techniques to obtain the diffusion of the credit assets under partial observation and show that they have a specific excess return with respect to the benchmark. The investor performs a simple mean–variance allocation on credit assets. However, returns and variance matrix have to be computed by a numerical method such as Monte Carlo, because of the dynamics of the system and the non-linearity of the asset prices. We use the theory of Dirichlet forms to deal with the uncertainty on the excess returns. This approach provides an estimation of the bias and the variance of the optimal allocation, and return. We propose an application in the case of a sectorial allocation with Credit Default Swaps (CDS), fully calibrated with observable data or direct input given by the portfolio manager.

Suggested Citation

  • Guillaume Bernis & Laurence Carassus & Grégoire Docq & Simone Scotti, 2015. "Optimal Credit Allocation Under Regime Uncertainty With Sensitivity Analysis," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(01), pages 1-27.
    • Handle: RePEc:wsi:ijtafx:v:18:y:2015:i:01:n:s0219024915500028
    DOI: 10.1142/S0219024915500028
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    Citations

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    Cited by:

    1. Guillaume Bernis & Nicolas Brunel & Antoine Kornprobst & Simone Scotti, 2017. "Stochastic Evolution of Distributions - Applications to CDS indices," Post-Print halshs-01467736, HAL.
    2. Guillaume Bernis & Nicolas Brunel & Antoine Kornprobst & Simone Scotti, 2017. "Stochastic Evolution of Distributions - Applications to CDS indices," Documents de travail du Centre d'Economie de la Sorbonne 17007, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    3. Guillaume Bernis & Nicolas Brunel & Antoine Kornprobst & Simone Scotti, 2017. "Stochastic Evolution of Distributions - Applications to CDS indices," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-01467736, HAL.

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