Practical Financial Optimization: Decision Making for Financial Engineers

Chapter 11

Corporate Bond Portfolios

With Norbert Jobst¹

11.1 Preview

The corporate bond market is one of the largest and fastest growing segments of fixed income securities. Investors in corporate bonds must deal with the credit risk inherent in these securities, and their derivative products. In this chapter we discuss the integration of corporate bonds in asset portfolios. As a first step we integrate credit risk with market risk, and this requires advanced scenario generation methods and the use of suitable risk metrics. CVaR optimization models are well suited to this application. As a second step we manage the corporate bond assets using an indexation strategy, and apply index fund models from previous chapters. Empirical results with a large-scale application illustrate the effectiveness of the financial optimization models. We also test the sensitivity of the results to the assumptions made about the data or about the models.

11.2 Credit Risk Securities

The corporate bond market has been receiving increased attention recently. The rapid growth in the number of new issues since the early 1990s (Figure 4.4) coupled with the low yields and reduced liquidity in the government bond markets of the late 1990s and early 2000s have attracted investors to corporate products. The credit derivatives market has also burgeoned during the last decade, with the total outstanding amount of interest rate swaps for AA risk standing at over $43 trillion dollars, about eight times as much as ...