Title: How many bonds to efficiently diversify credit risk?
Authors: Sara Razmpa - LOIM (Switzerland) [presenting]
Florian Ielpo - Centre Economie de la Sorbonne (France)
Abstract: A now old literature has focused on the diversification effects obtained from increasing the number of securities in a portfolio. When the situation in the case of stocks is clear, the credit bonds one has received little attention so far. Using a dataset of 4 years of returns on individual credit bonds issued in Euro and in US Dollar, across the investment grade and the high yield world, we present results regarding the optimal number of bonds necessary when an investor needs to mitigate idiosyncratic risk efficiently. Many investors are using ETFs to gain an efficient access to the credit world as the asset class is usually found to be complex. Our results show that with 90 bonds, about 90\% of an investment grade index's performance is explained by the market factor. In the case of High Yield bonds, an investor would need twice as many bonds to obtain similar results. When then question the stability of these results across the different market environments, highlighting how the risk concentration in each specific market should have an impact over the number of bonds to be used to generate a decent index replication.