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Post by Sapphire Capital on Jul 16, 2008 6:15:43 GMT 4
Integrating Market and Credit Risk in Stochastic Portfolio Optimization JOSE L.B. FERNANDES Central Bank of Brazil; Universidad Carlos III de Madrid JOSE RENATO HAAS ORNELAS Central Bank of Brazil MARCELO YOSHIO TAKAMI Sr. Executive Office of Monetary Policy Risk Management Icfai Journal of Financial Risk Management, Vol. 5, No. 1, pp. 7-28, March 2008 Abstract: This paper has two main objectives. The first is to propose a measure to integrate the market and credit risk. We define a way to convert credit risk into market risk, and then define an integrated risk measure. Based on this integrated measure, an Adjusted Sharpe Index is defined as a metric to compare various portfolios in the surface frontier in terms of financial efficiency. Second, several methodologies of estimating efficient portfolios were evaluated, under the perspective of a global long-term investor, incorporating estimation risk and evaluating the effect of credit risk in the model selection. The results support the use of the Michaud (1998) resampling methodology as it offers better results in terms of financial efficiency, allocation stability and diversification. Using the Michaud approach, the efficient surface frontier is defined and generated. papers.ssrn.com/sol3/papers.cfm?abstract_id=1103782
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