On the use of contingent claims in portfolio selection problems

In this paper we propose some portfolio selection models with contingent claims to invest either in the fixed income market or in the stock option market. Firstly, we describe a possible solution of the portfolio choice problem in the fixed income market taking into account the default risk. With this purpose, we consider CDSs contracts to hedge the default risk of investments in bonds. Secondly, we use European options in two distinct portfolio problems: in a reward-risk portfolio framework, to hedge the underlying portfolio risk of some stock indexes. Since we use a large number of trading European option written on principal international stock indexes, we discuss how to reduce the dimensionality of the large-scale portfolio problems taking into account the liquidity of the options. Finally, we propose an ex post empirical analysis of different portfolio models with contingent claims. Keywords—contingent claims, credit default swaps, default risk, hedge strategy, performance strategy. HE objective of this paper is twofold. We discuss and we evaluate portfolio strategies using contingent claims in two different markets: the fixed income market and the stock option market. In the fixed income market, we describe the classical strategy based on the immunization principles and we proposed strategies that use credit default swaps (CDSs) to hedge the default risk. In the stock option market, we describe portfolio strategies with only options either to hedge the market risk of some stock indexes or for speculative scopes. In the last decade, a deep process of transformation and innovation in which the financial engineering has introduced and developed new financial instruments and markets has characterized the financial international system. Among new financial contracts, we analyze the CDSs and the options applied in different markets (fixed income market and stock option market). The CDSs allow transferring the risk of insolvency. In particular, a subject that has a credit exposure towards a counterpart considered unreliable transfer the risk of insolvency to another operator willing to assume this risk.