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Article

Capital Allocation and Per-Unit Risk in Inhomogeneous
and Stressed Credit Portfolios

Gregor Dorfleitner and Tamara Pfister
The Journal of Fixed Income Winter 2013, 22 (3) 64-78; DOI: https://doi.org/10.3905/jfi.2012.22.3.064
Gregor Dorfleitner
is a professor in the Department of Finance and director of the Center of Finance at the University of Regensburg in Regensburg, Germany.
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  • For correspondence: gregor.dorfleitner@wiwi.uni-regensburg.de
Tamara Pfister
is a Ph.D. student in the Department of Finance at the University of Regensburg in Regensburg, Germany.
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  • For correspondence: tamara.pfister@gmx.de
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Abstract

This article considers the application of gradient allocation and portfolio optimization to credit portfolios. The assumption of linearity of risk that is implied by the use of gradient allocation is challenged in a setting of inhomogeneity and stress scenarios. To see the effects of mathematically derived portfolio optimization on real-life examples, we consider a number of insightful examples. This challenges mathematical results and enables a financial interpretation of the latter. The results reveal that per-unit risk is not disturbed by moderate inhomogeneity in most cases, whereas a change in portfolio composition as well as stress can influence the portfolio optimization decision significantly. The importance of incorporating sensitivity analysis and stress testing into reporting structures and optimization decisions is emphasized.

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The Journal of Fixed Income: 22 (3)
The Journal of Fixed Income
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Winter 2013
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Capital Allocation and Per-Unit Risk in Inhomogeneous
and Stressed Credit Portfolios
Gregor Dorfleitner, Tamara Pfister
The Journal of Fixed Income Dec 2012, 22 (3) 64-78; DOI: 10.3905/jfi.2012.22.3.064

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Capital Allocation and Per-Unit Risk in Inhomogeneous
and Stressed Credit Portfolios
Gregor Dorfleitner, Tamara Pfister
The Journal of Fixed Income Dec 2012, 22 (3) 64-78; DOI: 10.3905/jfi.2012.22.3.064
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  • Article
    • Abstract
    • PRINCIPLES AND NOTATION
    • PER-UNIT RISK IN INHOMOGENEOUS AND STRESSED CREDIT PORTFOLIOS
    • MONTE CARLO EVIDENCE
    • CONCLUSION AND MANAGERIAL IMPLICATIONS
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