Optimal investment with counterparty risk: a default-density modeling approach

By Ying Jiao, Huyen Pham. 2009

58 citations recorded by the source corpus.

We consider a financial market with a stock exposed to a counterparty risk inducing a drop in the price, and which can still be traded after this default time. We use a default-density modeling approach, and address in this incomplete market context the expected utility maximization from terminal wealth. We show how this problem can be suitably decomposed in two optimization problems in complete market framework: an after-default utility maximization and a global before-default optimization problem involving the former one. These two optimization problems are solved explicitly, respectively by duality and dynamic programming approaches, and provide a fine understanding of the optimal strategy. We give some numerical results illustrating the impact of counterparty risk and the loss given default on optimal trading strategies, in particular with respect to the Merton portfolio selection problem.

Subfields: Finance, Management Science and Operations Research

View Paper: https://www.semanticscholar.org/paper/3fc844b992dca3ba2180978fbeea6f6b24c1641f

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In Finance

1. José E. Figueroa-López
2. Agostino Capponi
3. Matthew F. Dixon
4. C. Houdr'e

In Management Science and Operations Research

1. José E. Figueroa-López
2. Agostino Capponi
3. C. Houdr'e

Citations in the corpus

• DYNAMIC PORTFOLIO OPTIMIZATION WITH A DEFAULTABLE SECURITY AND REGIME‐SWITCHING (2011, background): “Jiao and Pham (2011) combined duality and dynamic programming to optimize the utility of an investor with CRRA utility function, in a market consisting of a riskless bond and a stock subject to counterparty risk.”