Three essays on credit risk and portfolio optimization problem

Abstract

however, the impact of high CSR concerns on the CDS spreads is reinforced in the financial crisis period. The results are robust when controlling key firm-specific default characteristics and when considering endogeneity issues. The third essay proposes a new portfolio optimization approach that does not rely on the covariance matrix and attains a higher out-of-sample Sharpe ratio than the existing approaches. Our approach is free from the problems related to the estimation of the covariance matrix, solves the corner solution problems of the Markowitz model in practice, improves the out-of-sample estimation of portfolio mean, and enhances the performance of portfolio by imposing certain structure on asset returns. Although the shrinkage to market estimator method shows the smallest out-of-sample standard deviation, it cannot perform the best in terms of Sharpe ratio when compared to our approach.

This dissertation consists of three essays on Credit Risk and Portfolio Optimization Problem. In the first essay, I analyze the effect of credit rating change on credit default swap (CDS) spreads focusing on the characteristics of rating information. I introduce a framework where a credit spread is estimated by two signals of intrinsic credit quality (i.e., credit rating and market information), while in general event study the change of credit spread is interpreted as a process that a credit spread reflects the intrinsic market quality. In our framework, credit spreads are affected by relative credibility of rating and timeliness of rating to market information. To test our model implication, I check the relative position of credit spread of credit event among the spreads in the same rating. By using our approach, I confirm that credit ratings are not announced timely especially for downgrade, and credibility of rating is lower before downgrade than before upgrade. Our results are consistent with the “double reputations” problem of credit rating agency, and results of previous research using general event study. In the second essay, I examine the relationship between corporate social responsibility (CSR) and corporate credit default risk. I test the impact of CSR strengths and concerns on Credit Default Swap (CDS) spreads for the financial crisis period (2008-2009) as well as the non-crisis period (2001-2007 and 2010-2011). I use CDS spreads as a measure of credit default risk, which purely reflects the credit risk of a firm. Our empirical results show that firms with high CSR are likely to be assessed to have relatively low credit default risk during the non-crisis period. On the other hand, the effects vary during the financial crisis period. The impact of high CSR strengths on CDS spreads decreases significantly during the financial crisis