Application of conditional value at risk for credit risk optimization

The article is dedicated to the optimization of credit risk through the application of Conditional Value at Risk (CVaR). CVaR is a risk measure, the expected loss exceeding Value-at-Risk and is also known as Mean Excess, Mean Shortfall, or Tail VaR. The link between credit risk and the current financial crisis accentuates the importance of measuring and predicting extreme credit risk. Conditional Value at Risk has become an increasingly popular method for measurement and optimization of extreme market risk. The use of model can regulate all positions in a portfolio of financial instruments in order to minimize CVaR subject to trading and return constraints at the same time. The credit risk distribution is created by Monte Carlo simulations and the optimization problem is solved effectively by linear programming. We apply these CVaR techniques to the optimization of credit risk on portfolio of selected bonds. Keywords: value at risk; conditional value at risk; credit risk; portfolio