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Credit portfolio selection with decaying contagion intensities
Author(s) -
Bo Lijun,
Capponi Agostino,
Chen PengChu
Publication year - 2019
Publication title -
mathematical finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.98
H-Index - 81
eISSN - 1467-9965
pISSN - 0960-1627
DOI - 10.1111/mafi.12177
Subject(s) - portfolio , economics , position (finance) , bellman equation , comparative statics , order (exchange) , econometrics , value (mathematics) , function (biology) , mathematical economics , mathematics , financial economics , microeconomics , finance , statistics , evolutionary biology , biology
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.