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The Journal of Structured Finance

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Article

Credit-Risk Behavior of Homogeneous Portfolios: A Theoretical Result with Surprising Practical Implications

Bernardo K. Pagnoncelli, Francisco Hawas and Arturo Cifuentes
The Journal of Structured Finance Summer 2016, 22 (2) 7-15; DOI: https://doi.org/10.3905/jsf.2016.22.2.007
Bernardo K. Pagnoncelli
is an associate professor at the Business School at Universidad Adolfo Ibanez in Santiago, Chile.
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  • For correspondence: bernardo.pagnoncelli@uai.cl
Francisco Hawas
is a doctoral student in the Department of Applied Mathematics and Statistics at Stony Brook University in Stony Brook, NY.
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  • For correspondence: francisco.hawas@gmail.com
Arturo Cifuentes
is the academic director of the Financial Regulation and Macroeconomic Stability Center (CREM) and a faculty member in the Economics and Business School at the University of Chile in Santiago, Chile.
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  • For correspondence: arturo.cifuentes@fen.uchile.cl
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Abstract

This article describes an analytical approach to examine the credit-risk behavior of a homogeneous portfolio. The authors demonstrate the usefulness of the approach using a synthetic index linked to high-yield corporate bonds (which resembles a synthetic CDO) and then analyze an actual synthetic CDO transaction. They show that the conventional approach to analyze these structures (Monte Carlo simulations combined with the Gaussian copula) fails to account for the tri-modal nature of the underlying portfolio default distribution, and consequently, risk assessments based on this method give a misguided view of the risk–reward profile of such portfolios. The authors further show that the benefits of portfolio diversification in the context of credit-risk portfolios are limited in high-correlation scenarios. These findings have important implications for risk managers and financial regulators.

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The Journal of Structured Finance: 22 (2)
The Journal of Structured Finance
Vol. 22, Issue 2
Summer 2016
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Credit-Risk Behavior of Homogeneous Portfolios: A Theoretical Result with Surprising Practical Implications
Bernardo K. Pagnoncelli, Francisco Hawas, Arturo Cifuentes
The Journal of Structured Finance Jul 2016, 22 (2) 7-15; DOI: 10.3905/jsf.2016.22.2.007

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Credit-Risk Behavior of Homogeneous Portfolios: A Theoretical Result with Surprising Practical Implications
Bernardo K. Pagnoncelli, Francisco Hawas, Arturo Cifuentes
The Journal of Structured Finance Jul 2016, 22 (2) 7-15; DOI: 10.3905/jsf.2016.22.2.007
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