Modeling Illiquid Emerging-Market Corporate Bonds in Portfolios

Summary

The document considers how to include single-name emerging-market corporate bonds in a multi-asset portfolio when their histories are short, missing, or unreliable and trading is illiquid. Because these holdings make up a material share of the portfolio, excluding them from optimization could misrepresent portfolio risk. The question is how to estimate bond inputs despite limited market data.

A suggested approximation is to estimate a proxy yield from peer-group characteristics such as credit rating and currency. This can provide an input when a bond lacks a meaningful price history, but it does not capture the bond’s liquidity premium. If credit-rating history is also unavailable, the response points to a structural credit model such as KMV, which estimates yield using balance-sheet information. These are suggestions rather than a tested comparison: the document supplies no calibration, performance evidence, or implementation details. Any modeled yields and resulting portfolio weights therefore depend on proxy quality and should be treated cautiously, especially for illiquid bonds with sparse or changing credit information.

Key ideas

• Peer-group characteristics such as rating and currency can help estimate a proxy yield when bond histories are inadequate.
• A peer-based yield estimate may omit the liquidity premium.
• A structural credit model can be considered when rating history is unavailable, using balance-sheet information to estimate yield.
• The document presents possible modeling approaches but no validation or performance comparison.

Tags

# Portfolio optimization: how to take care of single name corporate bonds?


# Portfolio optimization: how to take care of single name corporate bonds?












I'm trying to backtest some strategies which include 3-5 years single name EM corporate bonds. Some of them don't even have a meaningful historical data. Some others are pretty illiquid. Other than these, my portfolio contains ETFs, equities, FX, and Commodities - pretty much multi asset class portfolio.

For risk management purposes I separated these bonds and looking at them from a different angle. But leaving them out in portfolio optimization will be a bad idea as these bonds account for 20-30% of the overall portfolio.

I guess my question is is it possible to somehow model EM single name corporate bonds? Has anybody come across a similar problem/project? Any resources that you can recommend?

## Answer by Yugmorf (score 1)

https://quant.stackexchange.com/a/33737

One way might be to calculate a proxy yield based on peer group metrics such as credit rating and currency. This won't however make any allowance for the liquidity premium, but nonetheless, it might still be a useful approximation. If the credit rating history is not available, then you might have to use something like the KMV model (part of Moody's Analytics) which can be used to estimate a yield based on balance sheet structure.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.