Downside Risk and VAR-Based optimal Portfolio Including Corporate Bonds and CDS

Abstract

This study examines the risk management characteristics, to seek diversification and hedging benefits of investment portfolio for pair of 5-year industrial corporate bonds and CDS of same industry, different techniques; VaR Reduction, expected shortfall reduction, semi VaR Reduction and Regret Reduction is applied on 3 types of portfolio strategies, i.e.  Risk minimization strategy portfolio (P2), Variance minimization portfolio strategy (P3), equally weighted Portfolio strategy (P4). The dataset used in this study comprises of daily closing quotations of 9 US industry’s bond return indices and their analogous 5-year industry’s CDS spread index. The industries included in the analysis are Energy, Industrials, Utility, Health, Telecommunications, Utilities, Banks, Information and Technology (Infotech) and Leisure. Thomson Reuters DataStream is the source for all data of markets. The results indicate that Risk reduction benefit is negative for all the industries for pair of their corporate bonds and respective CDS is negative for both P2 (Risk minimization portfolio) and P4 (equally weighted Portfolio), which makes them less attractive for portfolio diversification and unable to reduce downside risk for investment portfolios in which both of these pairs are included simultaneously.