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High Yield Corporate Bond Portfolio Optimization
KTH, School of Engineering Sciences (SCI), Mathematics (Dept.), Optimization and Systems Theory.
KTH, School of Engineering Sciences (SCI), Mathematics (Dept.), Optimization and Systems Theory.
2014 (English)Independent thesis Basic level (degree of Bachelor), 10 credits / 15 HE creditsStudent thesisAlternative title
Portföljoptimering för högavkastande företagsobligationer (Swedish)
Abstract [en]

The fixed maturity, cash flow and risk characteristics of high-yield corporate bonds distinguish them from equities and complicate a direct application of well established optimization techniques such as Markowitz's mean-variance model and Sharpe ratio maximization. This can partly explain why qualitative methods constitute the dominant design in the portfolio selection process of high-yield corporate bonds. This thesis attempts to employ elements from Markowitz's theories and combine them with optimization- as well as financial theory in order to develop a quantitative optimization model. In addition, we examine the possibilities for a shift in the existing dominant design. A risk-neutral pricing model were used to estimate default probabilities of high yield corporate bonds. To approximate the covariance matrix, a new application of the single-index method were proposed. The derived optimization models produced results that coincide with financial theory regarding risk, return and diversification. Furthermore, an examination of a potential shift in the current dominant design suggests that a shift is not likely to occur in the near future. A reoccurring remark in this thesis is the importance to understand the underlying assumptions behind any quantitative model, suggesting that quantitative models can merely be used as a tool in combination with a human judgement.

Abstract [sv]

Högavkastande företagsobligationer innehar egenskaper som särskiljer de från aktier. Detta medför komplikationer vid en direkt tillämpning av väletablerade optimeringsmodeller som 'Markowitz's mean-variance model' och 'Sharpe ratio maximisation'. Detta förklarar delvis varför kvalitativa metoder dominerar portföljallokeringsprocessen för högavkastande företagsobligationer. Examensarbetet kombinerar Markowitzs modell med teorier från optimeringslära och finansiell matematik i syfte att utveckla en kvantitativ optimeringsmodell för portföljallokering. Arbetet ämnar även till att undersöka möjligheterna för ett skift i den nuvarande dominanta processen för allokering av högavkastande företagsobligationer. En riskneutral prissättningsmodell tillämpades för att estimera sannolikheter att företagen går i konkurs. För att approximera kovariansmatrisen introduceras en ny tillämpning av 'single-index method'. De härledda optimeringsmodellerna visade på resultat som sammanfaller med finansiell teori angående risk, avkastning och diversifiering. En analys av möjligheterna för ett potentiellt skift i den dominerande processen påvisade att detta förmodligen ej kommer att ske inom en snar framtid. En återkommande anmärkning i detta examensarbete ar vikten av modellmedvetenhet och att således ha kunskap om de underliggande antaganden som modellen bygger på, vilket framgår av slutsatsen att kvantitativa metoderna enbart kan användas som ett verktyg och därav agera som ett underlag för beslutsfattande.

Place, publisher, year, edition, pages
2014.
Series
TRITA-MAT-K, 2014:18
Keyword [en]
high-yield corporate bonds, optimization, dominant design
National Category
Mathematical Analysis
Identifiers
URN: urn:nbn:se:kth:diva-146746OAI: oai:DiVA.org:kth-146746DiVA: diva2:725544
Subject / course
Applied Mathematical Analysis
Educational program
Master of Science in Engineering - Industrial Engineering and Management
Supervisors
Examiners
Available from: 2014-06-16 Created: 2014-06-15 Last updated: 2014-06-16Bibliographically approved

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