Working Paper No. 199
This paper studies the role of diversification in reducing the volatility of corporate bond returns induced by changes in credit spreads. Specifically, it looks at how credit risk can be diminished when a portfolio is diversified across countries, industry sectors, maturities, seniority types and credit ratings. The role of national industrial structures for international diversification is also investigated. The results suggest that geographical diversification is more effective in reducing portfolio risk than alternative investment strategies considered, and that industry effects are not material to this result. Finally, the paper explores the implications of these findings for credit risk capital regulation in banks.