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Credit Risk Diversification

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  • Simonne Varotto

    (ICMA Centre, University of Reading)

Abstract

We study the role of diversification in reducing the volatility of corporate bond returns induced by changes in credit spreads. Specifically, we look at how credit risk can be diminished when a portfolio is diversified across countries, industry sectors, maturities, seniority types and credit ratings. The role of national industrial structures on international diversification is also investigated. Our results show that geographical diversification is more effective in reducing portfolio risk than any alternative investment strategy we consider, and that industry effects are not material to this result. Finally, we explore the implications of our findings for credit risk capital regulation in banks.

Suggested Citation

  • Simonne Varotto, 2001. "Credit Risk Diversification," ICMA Centre Discussion Papers in Finance icma-dp2001-07, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2001-07
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2001-07.pdf
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    References listed on IDEAS

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    Cited by:

    1. Lopez, Jose A., 2004. "The empirical relationship between average asset correlation, firm probability of default, and asset size," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 265-283, April.
    2. Jackson, Patricia & Perraudin, William & Saporta, Victoria, 2002. "Regulatory and "economic" solvency standards for internationally active banks," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 953-976, May.

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    More about this item

    Keywords

    Credit Risk Diversification; Globally and locally systematic risk; bond ratings;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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