Systemic risk of portfolio diversification

This paper studies the vulnerability arising from the corporate loan holdings of collateralized loan obligations (CLOs) using a network reconstruction method and stress tests. Because of the portfolio diversification requirement imposed on the management of CLOs, some corporate loans are held by multiple CLOs. This commonality of corporate loans among CLO portfolios suggests the possibility that the diversification of risk in each CLO is not as high as it may appear from the perspective of the entire market. Stress tests show that portfolio diversification of securitization as observed in the CLO loan holdings is not necessarily effective in enhancing system-wide robustness against the idiosyncratic defaults of the underlying assets. (C) 2021 Elsevier B.V. All rights reserved.