Analytical methods for hedging systematic credit risk with linear factor portfolios

Multi-factor credit portfolio models are used widely today for managing economic capital and pricing collateralized debt obligations (CDOs) and asset-backed securities. Commonly, practitioners allocate capital to the portfolio components (sub-portfolios, counterparties, or transactions). The hedging...

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Bibliographic Details
Published in:Journal of economic dynamics & control 2009, Vol.33 (1), p.37-52
Main Authors: Rosen, Dan, Saunders, David
Format: Article
Language:English
Subjects:
Asset backed securities
Capital
Capital allocation
Collateralized debt obligations
Credit
Credit risk
Credit risk Factor models Hedging Capital allocation
Factor models
Hedging
Linear models
Portfolio investments
Portfolio management
Pricing
Risk
Studies
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Summary:Multi-factor credit portfolio models are used widely today for managing economic capital and pricing collateralized debt obligations (CDOs) and asset-backed securities. Commonly, practitioners allocate capital to the portfolio components (sub-portfolios, counterparties, or transactions). The hedging of credit risk is generally also focused on the ‘deltas’ of underlying names. We present analytical results for hedging portfolio credit risk with linear combinations of systematic factors, based on the minimization of systematic variance of portfolio losses. We solve these problems within a multi-factor Merton-type credit portfolio model, and apply them to hedge systematic credit default losses of loan portfolios and CDOs.
ISSN:0165-1889
1879-1743
DOI:10.1016/j.jedc.2008.03.010