Dependence and Risk Management

Portfolio optimization for credit-risky assets under extreme dependence

We consider power utility maximization in a multivariate Black-Scholes model that is enhanced by credit risk via the Marshall-Olkin exponential distribution. On the practical side, the model is analytically tractable, easy to interpret, and thus simple to implement. On the theoretical side, the model constitutes a well-justified and intuitive mathematical wrapping to study the effect of extreme and higher-order dependence on optimal portfolios. In particular, we show that it is rich enough to model both, situations in which diversification is beneficial and situations in which this is not the case.

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