Litterman and Scheinkman (1991) showed that even a duration immunized fixed-income portfolio (neutral) can bear great losses and, therefore, propose hedging the portfolio using a principal component's analysis. The problem is that this approach is only possible when the interest rates are observable. Therefore, when the interest rates are not observable, as is the case of most international and domestic debt markets in many emerging market economies, it is not possible to apply this method directly. The present study proposes an alternative approach: hedging based on factors of a parametric term structure model. The immunization done using this approach is not only simple and efficient but also equivalent to the immunization procedure proposed by Litterman and Scheinkman when the rates are observable. Examples of the method for hedging and leveraging operations in the Brazilian inflation-indexed public debt securities market are presented. This study also describes how to construct and to price portfolios that replicate the model risk factors, which makes possible to extract some information on the expectations of agents in regards to future behavior of the interest rate curve.

<p>There is evidence that jumps double the explanatory power of Campbell and Shiller (1991) excess bond returns’ regressions (Wright and Zhou, 2009), and options bring information about bond risk premia beyond that spanned by the yield curve (Joslin, 2007). In this paper I incorporate these features in a Gaussian Affine Term Structure Model (ATSM) in order to assess two questions: (1) what are the implications of incorporating jumps in an ATSM for option pricing, and (2) how jumps and options affect the bond risk-premia dynamics.</p><p>The main findings are: (1) jump risk-premia is negative in a scenario of decreasing interest rates, and has a significant average magnitude of 1% to 2%, which means that, it explains 10% to 20% of the level of the yields; (2) the Gaussian model (A30) and the Gaussian model with constant intensity jumps (A30J) are the ones that best fit the option prices; and (3) the Gaussian model with constant intensity jumps estimated jointly with options (A30oJ) is the one that best identifies the risk premium.</p>