N. Mirjolet, G. Dondi, F. Herzog, S. Keel, and H.P. Geering (Switzerland)
Corporate Bond Pricing, Credit Portfolio Optimization,
Hull-White Term Structure Model
In this paper, we provide an optimization and simulation
framework allowing corporate bond portfolio managers to
follow or outperform a given benchmark index with the
help of only a small set of bonds. The underlying bond
pricing model integrates the main sources of risks, such as
market or credit risk. Correlated stochastic interest rates
and credit spreads, independent rating migrations, based on
empirical transition matrices, are incorporated in a uniﬁed
intensity-based pricing framework. However, contrary to
the traditionnal approach, we avoid the use of Monte-Carlo
simulations by deriving the explicit price distribution of a
corporate coupon bond.
Based upon the bond pricing model, we formulate and
solve a one period tracking error problem as a linear pro
gram. Multiple optimization constraints allow to accurately
manage and control the credit risk.
Empirical results obtained by dynamically replicating the
JPMorgan Aggregated Euro Credit Index over a ﬁve year
recent period substantiate the conclusions of this paper.