Managing Sovereign Credit Risk with Derivatives
The aim of our study is to develop a dynamic hedging model where the bank management can use credit derivatives, such as sovereign credit default swaps to hedge sovereign credit risk. For buyers of sovereign credit derivatives, the credit derivative market offers the opportunity to reduce credit concentration; for sellers of protection, sovereign credit derivatives offer the opportunity to take exposure. In a continuous-time framework the hedging policy of a bank is studied. The optimal hedge ratio consists of two elements: a pure hedge and a speculative hedge term. Primarily the purpose of hedging is to stabilize the wealth accumulation.
KeywordsRisk Premium Credit Risk Credit Default Swap Loan Portfolio Wealth Accumulation
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