Debt portfolios with higher risk aversion
For each spread class basket the potential spread widening in a stress case has to be estimated. Agood starting point are the historic observations. Sometimes portfolio managers might be very prudent and add quite a significant amount of spread change to historic extremes. They should be aware, however, that this has repercussions on the whole portfolio. Higher risk estimates lead to portfolios with higher risk aversion which on a strategic level leads to lower expected return and on the implementation level to lower spreads and therefore a lower income stream. This in turn affects the risk budget and so on. Dynamic portfolio protection is a path-dependent strategy and the decision for higher risk aversion on a single name level leads the portfolio towards certain paths and excludes others.
