Credit Value-at-Risk in Corporate Bond Portfolio Management

Very Hard Risk Management Applications Credit Risk Management

A financial institution is evaluating its portfolio of corporate bonds and their associated credit risks. Recently, the institution has experienced a significant increase in default probabilities related to several of its investments. To address this concern, the Chief Risk Officer proposes the use of a credit value-at-risk (CVaR) method alongside a Monte Carlo simulation framework to quantify potential losses from credit events.

The institution has a diversified portfolio with varying credit ratings and industry exposures. Given the proposal, the board of directors is particularly interested in understanding how this approach could affect the institution's risk profile, especially under stress conditions where credit spreads widen sharply.

Which of the following best captures the advantage of employing a CVaR approach in the context of this institution's credit risk management strategy?

It allows for the assessment of expected shortfall in case of extreme credit losses without considering the correlation between asset returns.

It accommodates the nonlinearities in credit spreads and provides a more comprehensive view of tail risk by factoring in joint default probabilities.

It simplifies the risk assessment process by using historical data only, ignoring future market scenarios and conditions.

Hint

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