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FIXED INCOME PORTFOLIOS SUBJECT6

Fixed Income Portfolios Subject to Credit Risk: Rethinking the Fundamentals

The subprime crisis shook the foundations of the global financial system and exposed the weaknesses behind current credit-risk models. We argue that tweaking or fine-tuning such models is unlikely to improve their predictive capabilities as they were not designed to capture the trimodal hape of the loss distributions that characterize those portfolios. Moreover, the binary (yes-no) aspect of default events implies that subordination in securitization vehicles not always offers the desired protection. Finally, we show that in credit-risk portfolios the power of diversification is modest when compared to more conventional (equities or high-quality bonds) portfolios.

Autores: Arturo Cifuentes, Bernardo K. Pagnoncelli

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