We introduce an equity-credit portfolio framework taking into account the structural interaction of market and credit risk, along with their systemic dependencies. We derive an explicit expression for the optimal investment strategy in stocks and credit default swaps (CDSs). We exploit its representation structure and analyze the mechanisms driving the optimal investment decisions. The transmission of market risk premia is the key mechanism through which systemic influences affect the optimal investment strategy. We develop a novel calibration procedure and find that systemic dependencies are statistically significant when the model is fitted to historical time series of equity and CDS data. An empirical analysis with data of companies in the Dow Jones Industrial Average 30 reveals the critical role of systemic risk in portfolio monitoring. This paper was accepted by Noah Gans, stochastic models and simulation.

We study the exponential utility indifference value h for a contingent claim H in an incomplete market driven by two Brownian motions. The claim H depends on a non-tradable asset variably correlated with the traded asset available for hedging. We provide an explicit sequence that converges to h, complementing the structural results for h known from the literature. Our study is based on a convergence result for quadratic backward stochastic differential equations. This convergence result, which we prove in a general continuous filtration under weak conditions, also yields that the indifference value in a setting with trading constraints enjoys a continuity property in the constraints.

Many financial arrangements reference market prices that are yet to be realized at the time of contracting and consequently susceptible to manipulation. Two of the most common such arrangements are as follows: (i) guaranteed volume-weighted average price (VWAP) contracts, which reference the VWAP prevailing over an execution window, and (ii) market-on-close contracts, which reference the price prevailing at the window’s end. To study such situations, we introduce a stylized model of financial contracting between a client, who wishes to trade a large position, and the client’s dealer. We provide conditions under which guaranteed VWAP contracts are optimal in this principal-agent problem. In contrast, market-on-close contracts generally cannot be optimal. These results explain the use of guaranteed VWAP contracts in practice, question the use of market-on-close contracts, and suggest considerations for the design of financial benchmarks. This paper was accepted by Haoxiang Zhu, finance.