Bruder, Benjamin and Hereil, Pierre and Roncalli, Thierry (2011): Managing sovereign credit risk in bond portfolios.
Download (1970Kb) | Preview
With the recent development of the European debt crisis, traditional index bond management has been severely called into question. We focus here on the risk issues raised by the classical market-capitalization weighting scheme. We propose an approach to properly measure sovereign credit risk in a fixed-income portfolio. For that, we assume that CDS spreads follow a SABR process and we derive a sovereign credit risk measure based on CDS spreads and duration of portfolio bonds. We then consider two alternative weighting methods which are fundamental indexation and risk-based indexation. Fundamental indexation is based on GDP indexation whereas risk-based indexation uses a risk budgeting approach based on our sovereign credit risk measure. We then compare all these methods in terms of risk, diversification and performance. We show that the risk budgeting approach is the most appropriate scheme to manage sovereign credit risk in bond portfolios and gives very appealing results with respect to active management of bond portfolios.
|Item Type:||MPRA Paper|
|Original Title:||Managing sovereign credit risk in bond portfolios|
|Keywords:||sovereign credit risk, credit spread, convex risk measure, sabr model, CDS, bond indices, fundamental indexation, risk-based indexation, risk budgeting|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
H - Public Economics > H6 - National Budget, Deficit, and Debt > H63 - Debt; Debt Management; Sovereign Debt
C - Mathematical and Quantitative Methods > C6 - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling > C60 - General
|Depositing User:||Thierry Roncalli|
|Date Deposited:||15. Feb 2012 15:27|
|Last Modified:||12. Feb 2013 06:10|
Arnott R.D. (2009), Bonds: Why Bother?, Journal of Indexes, 12(3), pp. 10-17.
Arnott R.D. (2010), Debt Be Not Proud, Journal of Indexes, 13(6), pp. 10-17.
Arnott R.D., Hsu J.C., Li F. and Shepherd S.D. (2010), Valuation-Indifferent Weighting for Bonds, Journal of Portfolio Management, 36(3), pp. 117-130.
Arnott R.D., Hsu J.C. and Moore P. (2005), Fundamental Indexation, Financial Analysts Journal, 61(2), pp. 83-99.
Artzner A., Delbaen F., Eber J.-M. and Heath D. (1999), Coherent Measures of Risk, Mathematical Finance, 9(3), pp. 203-228.
Blake C.R., Elton E.J. and Gruber M.J. (1993), The Performance of Bond Mutual Funds, Journal of Business, 66(3), pp. 371-403.
Brodsky B., Flannery G. and Mesrour S. (2011), Introducing the BlackRock Sovereign Risk Index: A More Comprehensive View of Credit Quality, BlackRock Investment Institute, White Paper.
Bruder B., Hereil P. and Roncalli T. (2011), Mesurer et gérer le risque de crédit souverain de la zone euro, Revue Banque, 740, pp. 48-50.
Bruder B., Hereil P. and Roncalli T. (2011), Managing Sovereign Credit Risk, Journal of Indexes Europe, 1(4), pp. 20-27.
Cantor R. and Packer F. (1996), Determinants and Impact of Sovereign Credit Rating, Federal Reserve Bank of New York Economic Policy Review, 2(2), pp. 1-15.
Choueifaty Y. and Coignard Y. (2008), Towards Maximum Diversification, Journal of Portfolio Management, 35(1), pp. 40-51.
Clarke R., de Silva H. and Thorley S. (2006), Minimum-variance Portfolios in the U.S. Equity Market, Journal of Portfolio Management, 33(1), pp. 10-24.
Crockett A. (1997), Why Is Financial Stability a Goal of Public Policy?, Federal Reserve Bank of Kansas City Economic Review, Q IV, pp. 5-22.
Demey P., Maillard S. and Roncalli T. (2010), Risk-Based Indexation, Lyxor White Paper Series, 1, www.lyxor.com.
DeMiguel V., Garlappi L. and Uppal R. (2009), Optimal Versus Naive Diversification: How Inefficient is the 1/N Portfolio Strategy?, Review of Financial Studies, 22, pp. 1915-1953.
Di Cesare A. (2006), Do Market-based Indicators Anticipate Rating Agencies? Evidence for International Banks, Economic Notes, 35(1), pp. 121-150.
Ejsing J. and Lemke W. (2011), The Janus-Headed Salvation: Sovereign and Bank Credit Risk Premia during 2008–2009, Economics Letters, 110(1), pp. 28-31.
Eychenne K., Martinetti S. and Roncalli T. (2011), Strategic Asset Allocation: An Update following the Sovereign Debt Crisis, www.lyxor.com.
Gilles C. and LeRoy S.F. (1997), Bubbles as Payoffs at Infinity, Economic Theory, 9(2), pp. 261-281.
Goltz F. and Campani C.H. (2011), A Review of Corporate Bond Indices: Construction Principles, Return Heterogeneity, and Fluctuations in Risk Exposures, EDHEC Risk Institute.
Gray D.F., Bodie Z. and Merton R.C. (2007), Contingent Claims Approach to Measuring and Managing Sovereign Risk, Journal of Investment Management, 5(4), pp. 5-28.
Hagan P.S., Kumar D., Lesniewski A.S. and Woodward D.E. (2002), Managing Smile Risk, Wilmott Magazine, July, pp. 84-108.
Hilscher J. and Nosbusch Y. (2010), Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt, Review of Finance, 14, pp. 235–262.
Hereil P., Moussavi N., Mitaine P. and Roncalli T. (2010), Mutual Fund Ratings and Performance Persistence, Lyxor White Paper Series, 3, www.lyxor.com.
Kindleberger C.P. (1939), Speculation and Forward Exchange, Journal of Political Economy, 47(2), pp. 163-181.
Kindleberger C.P. (2005), Manias, Panics, and Crashes: A History of Financial Crises, John Wiley & Sons, fifth edition (first edition in 1978).
Krugman P. (2009), The Return of Depression Economics and the Crisis of 2008, W.W. Norton & Company, (first edition in 1999).
Longstaff F.A., Pan J., Pedersen L.H. and Singleton K.J. (2007), How Sovereign is Sovereign Credit Risk?, NBER Working Paper, No. 13658.
Maillard S., Roncalli T. and Teiletche J. (2010), The Properties of Equally Weighted Risk Contributions Portfolios, Journal of Portfolio Management, 36(4), pp. 60-70.
Martellini L. (2008), Toward the Design of Better Equity Benchmarks, Journal of Portfolio Management, 34(4), pp. 1-8.
Merton R.C. (1974), On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, Journal of Finance, 29(2), pp. 449-470.
Meucci A. (2005), Risk and Asset Allocation, Springer.
Mundell R.A. (1961), A Theory of Optimum Currency Areas, American Economic Review, 51(4), pp. 657-665.
Reinhart C.M. and Rogoff K.S. (2009), This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
Reilly F.K., Kao G.W. and Wright D.J. (1992), Alternative Bond Market Indexes, Financial Analysts Journal, 48(3), pp. 44-58.
Roncalli T. (2011), Understanding the Impact of Weights Constraints in Portfolio Theory, Working Paper, ssrn.com/abstract=1761625.
Scherer B. (2007), Portfolio Construction & Risk Budgeting, third edition, Risk Books, 2007.
Spaventa L. (1987), The Growth of Public Debt: Sustainability, Fiscal Rules, and Monetary Rules, Staff Papers - International Monetary Fund, 34(2), pp. 374-399.
Toloui R. (2010), Time To Rethink Bond Indexes?, Journal of Indexes, 13(5), pp. 26-29.
Wyplosz C. (1999), International Financial Instability, in Kaul I., Stern M. and Grunberg I. (eds), International Development Cooperation and Global Public Goods: Toward Sustainable Development in the 21st Century, Oxford University Press, pp. 152-189.