Managing Credit Risk in Corporate Bond Portfolios : A Practitioner's ...

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ContentsviiDefault Correlation 98Relationship to Loss Correlation 99Estimating Default Correlation 100Default Mode: Two-Bond Portfolio 102Estimating Asset Return Correlation 104Factor Models 106Approximate Asset Return Correlations 109Credit Risk Under Migration Mode 111Computing Joint Migration Probabilities 114Computing Joint Credit Loss 114Migration Mode: Two-Bond Portfolio 115Portfolio Credit Risk 115Numerical Example 118Questions 121CHAPTER 7Simulating the Loss Distribution 123Monte Carlo Methods 123Credit Loss Simulation 125Generating Correlated Asset Returns 126Inferring Implied Credit Rating 128Computing Credit Loss 128Computing Expected Loss and Unexpected Loss 130Importance Sampling 131Tail Risk Measures 132Credit Value at Risk 132Expected Shortfall Risk 133Numerical Results 135Questions 138CHAPTER 8Relaxing the Normal Distribution Assumption 139Motivation 140Student’s t Distribution 140Probability Density Function 142Portfolio Credit Risk 142Default Mode 143Migration Mode 145Loss Simulation 149Appendix 151Questions 154
viiiCONTENTSCHAPTER 9Risk Reporting and Performance Attribution 155Relative Credit Risk Measures 156Marginal Credit Risk Contribution 160Portfolio Credit Risk Report 162Risk Reporting During Economic Contractions 165Portfolio Market Risk Report 168Risk Guidelines 169Performance Attribution 170A Simple Attribution Model 172Questions 175CHAPTER 10Portfolio Optimization 177Portfolio Selection Techniques 178Benefits of a Quantitative Approach 179Optimization Methods 180Linear Programming 180Quadratic Programming 181Nonlinear Programming 181Practical Difficulties 182Portfolio Construction 183Setting Up the Constraints 185The Optimization Problem 187Optimal Portfolio Composition 188Robustness of Portfolio Composition 191Portfolio Rebalancing 191Identifying Sell Transactions 192Identifying the Rebalancing Trades 194Numerical Results 197Devil in the Parameters: A Case Study 199Risk Reduction 203Questions 204CHAPTER 11Structured Credit Products 206Introduction to CDOs 207Balance Sheet versus Arbitrage CDOs 207Cash Flow versus Market Value CDOs 209Cash versus Synthetic CDOs 210Investor Motivations 210
Page 2: Managing Credit Risk inCorporate Bo
Page 5 and 6: THE FRANK J. FABOZZI SERIESFixed In
Page 7 and 8: Copyright © 2004 by Srichander Ram
Page 9: viCONTENTSPortfolio Management Styl
Page 14 and 15: ForewordSome of the greatest advanc
Page 16 and 17: PrefaceCurrently, credit risk is a
Page 18 and 19: CHAPTER 1IntroductionMOTIVATIONMost
Page 20 and 21: Introduction 3Chapter 3 provides a
Page 22 and 23: CHAPTER 2Mathematical Preliminaries
Page 24 and 25: Mathematical Preliminaries 7the dis
Page 26 and 27: Mathematical Preliminaries 9the sca
Page 28 and 29: Mathematical Preliminaries 11defaul
Page 30 and 31: Mathematical Preliminaries 13To pro
Page 32 and 33: Mathematical Preliminaries 15denote
Page 34 and 35: Mathematical Preliminaries 17The el
Page 36 and 37: Mathematical Preliminaries 19The ma
Page 38 and 39: Mathematical Preliminaries 21It imm
Page 40 and 41: CHAPTER 3The Corporate Bond MarketI
Page 42 and 43: The Corporate Bond Market 25of a ne
Page 44 and 45: The Corporate Bond Market 27longer
Page 46 and 47: The Corporate Bond Market 29that il
Page 48 and 49: The Corporate Bond Market 31regard
Page 50 and 51: The Corporate Bond Market 33policy
Page 52 and 53: The Corporate Bond Market 35Despite
Page 54 and 55: The Corporate Bond Market 37U.S. do
Page 56 and 57: The Corporate Bond Market 39EXHIBIT
Page 58 and 59: The Corporate Bond Market 41of dema
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The Corporate Bond Market 43specula
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The Corporate Bond Market 45The com
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The Corporate Bond Market 47The his
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The Corporate Bond Market 49Implica
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CHAPTER 4Modeling Market RiskIn bro
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Modeling Market Risk 53ConvexityFor
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Modeling Market Risk 55Risk measure
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Modeling Market Risk 57convexity ar
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Modeling Market Risk 59EXHIBIT 4.1P
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Modeling Market Risk 61OTHER SOURCE
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Modeling Market Risk 63The next tas
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Modeling Market Risk 65Note that fo
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CHAPTER 5Modeling Credit RiskCredit
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Modeling Credit Risk 69is intended
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Modeling Credit Risk 71I mentioned
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Modeling Credit Risk 73deviate from
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Modeling Credit Risk 75Captive Fina
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Modeling Credit Risk 77EXHIBIT 5.2
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79Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa
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Modeling Credit Risk 81EXHIBIT 5.4N
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Modeling Credit Risk 83EXHIBIT 5.6T
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Modeling Credit Risk 85Taking expec
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Modeling Credit Risk 87Taking expec
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Modeling Credit Risk 89fall under c
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Modeling Credit Risk 91Deriving Exp
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Modeling Credit Risk 93corresponds
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CHAPTER 6Portfolio Credit RiskThe f
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Portfolio Credit Risk 97given byUL
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Portfolio Credit Risk 99Because the
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Portfolio Credit Risk 101of their j
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Portfolio Credit Risk 103EXHIBIT 6.
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Portfolio Credit Risk 105Because th
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Portfolio Credit Risk 107because hi
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Portfolio Credit Risk 109model, ind
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Portfolio Credit Risk 111Financial
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113Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Ba
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Portfolio Credit Risk 115equal to l
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Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2
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119Issuer Nominal Dirty KMV’sS. N
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Portfolio Credit Risk 121EXHIBIT 6.
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CHAPTER 7Simulating the Loss Distri
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Simulating the Loss Distribution 12
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CHAPTER 8Relaxing the NormalDistrib
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Relaxing the Normal Distribution As
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147Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Ba
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Page 168 and 169:
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Page 172 and 173:
CHAPTER 9Risk Reporting andPerforma
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Risk Reporting and Performance Attr
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CHAPTER 10Portfolio OptimizationSo
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Portfolio Optimization 179only the
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Portfolio Optimization 181weights o
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Portfolio Optimization 183has to re
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Portfolio Optimization 185one wishe
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Portfolio Optimization 187Finally,
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Portfolio Optimization 189to each b
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Portfolio Optimization 191the bench
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Portfolio Optimization 193w i,Pw i,
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Portfolio Optimization 195recommend
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Portfolio Optimization 197If corpor
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Portfolio Optimization 199DEVIL IN
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Portfolio Optimization 201EXHIBIT 1
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Portfolio Optimization 203rate vola
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Portfolio Optimization 205duration
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Structured Credit Products 207the e
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Structured Credit Products 209manag
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Structured Credit Products 211equit
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Structured Credit Products 213EXHIB
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Structured Credit Products 217a giv
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Structured Credit Products 219fixed
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Structured Credit Products 221RATIN
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Page 242 and 243:
Structured Credit Products 225CDO i
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Structured Credit Products 227the c
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Structured Credit Products 229and t
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Structured Credit Products 231Main
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Structured Credit Products 233Becau
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Structured Credit Products 235arriv
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Solutions to End-of-ChapterQuestion
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Solutions to End-of-Chapter Questio
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NotesCHAPTER 31. Euro-denominated c
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Notes 2592. For details, see Willia
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Notes 2617. For details, see Sten B
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Index 263Bid-ask spread, 27, 50decr
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Index 265contribution. See Marginal
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Index 267Funding requirements, 41Fu
Page 286 and 287:
Index 269notation, 195product, 14-1
Page 288 and 289:
Index 271quantification, 95-98quant
Page 290 and 291:
Index 273Short-dated financial inst
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