Portfolio Diversification In Concentrated Bond And Loan Portfolios

Volume 14, Number 2, 2016
Paul Kupiec

I develop an algorithm to approximate the loss rate distribution for fixed income portfolios with obligor concentrations. The approximation requires no advanced mathematics or statistics, only the summation of large exposures and the evaluation of binomial probabilities. The approximation is model-independent and can be used after removing default dependence using any risk modeling approach. It is especially useful for capital calculations given its inherent accuracy in the upper tail of the cumulative portfolio loss rate distribution. The approximation provides a simple way to calculate the capital benefits of risk mitigation or the capital needed when a marginal credit is added to a concentrated portfolio.