The Tail that Wags the Dog: Integrating Credit Risk in Asset Portfolios

Abstract

Tails probabilities are of paramount importance in shaping the risk profile of portfolios with credit risk sensitive securities. In this context, risk management tools require simulations that accurately capture the tails, and optimization models that limit tail effects. Ignoring tail events in the simulation or using inadequate optimization metrics can have significant effects and reduce portfolio efficiency. The resulting portfolio risk profile can be grossly misrepresented when long‐run performance is optimized without accounting for short‐term tail effects. This article illustrates pitfalls and suggests models to avoid them.

Citation

JOBST, N.J. and ZENIOS, S.A. (2001), "The Tail that Wags the Dog: Integrating Credit Risk in Asset Portfolios", Journal of Risk Finance, Vol. 3 No. 1, pp. 31-43. https://doi.org/10.1108/eb043481