The art of risk management in bond portfolios

Bierwag, G. O.; Kaufman, George G.; Schweitzer, Robert; Toevs, Alden L.

doi:10.3905/jpm.1981.408806

Cited by 32 publications

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“…The last subsection is devoted to the risk measures derived from HJM models. 7 The reader interested in the literature related to the risk measures developed for certain yield curve behavior can refer to Bierwag, Kaufman, and Toevs (1981). Ingersoll, Skelton, and Weil (1978) introduce basis risk as the relative change in the bond price for an unexpected change in the interest rates, ceteris paribus.…”

Section: Risk Measures Derived From Specific Term Structure Modelsmentioning

confidence: 99%

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The Performance of Alternative Interest Rate Risk Measures and Immunization Strategies under a Heath-Jarrow-Morton Framework

Ağca

2005

J. Financ. Quant. Anal.

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The Heath-Jarrow-Morton (HJM) model represents the latest in powerful arbitragefree technology for modeling the term structure and managing interest rate risk. Yet risk management strategies in the form of immunization portfolios using duration, convexity, and M-square are still widely used in bond portfolio management today. This study addresses the question of how traditional risk measures and immunization strategies perform when the term structure evolves in the HJM manner. Using Monte Carlo simulation, I analyze four HJM volatility structures, four initial term structure shapes, three holding periods, and two traditional immunization approaches (duration-matching and duration-and-convexitymatching). I also examine duration and convexity measures derived specifically for the HJM framework. In addition I look at whether portfolios should be constructed randomly, by minimizing their M-squares or using barbell or bullet structures. I assess immunization performance according to three criteria. One of these criteria corresponds to active portfolio management, and the other two correspond to passive portfolio management. Under active portfolio management, an asset portfolio is successfully immunized if its holding period return is greater than or equal to the holding period return of the liability portfolio. Under passive iii portfolio management, the closer the returns of the asset portfolio to the returns of the liability portfolio, the better the immunization performance.The results of the study suggest that, under the active portfolio management criterion, and with the duration matching strategy, HJM and traditional duration measures have similar immunization performance when forward rate volatilities are low. There is a substantial deterioration in the immunization performance of traditional risk measures when there is high volatility. This deterioration is not observed with HJM duration measures. These results could be due to two factors. Traditional risk measures could be poor risk measures, or the duration matching strategy is not the most appropriate immunization approach when there is high volatility because yield curve shifts would often be large.Under the active portfolio management criterion and with the duration and convexity matching strategy, the immunization performance of traditional risk measures improves considerably at the high volatility segments of the yield curve. The improvement in the performance of the HJM risk measures is not as dramatic. The immunization performance of traditional duration and convexity measures, however, deteriorates at the low volatility segments of the yield curve. This deterioration is not observed when HJM risk measures are used. Overall, with the duration and convexity matching strategy, the immunization performance of portfolios matched with traditional risk measures is very close to that of portfolios matched with the HJM risk measures. This result suggests that the duration and convexity matching approach should be preferred to duration matching alone....

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Section: Risk Measures Derived From Specific Term Structure Modelsmentioning

confidence: 99%

“…Using Durand yield data for the period 1925, Bierwag, Kaufman, Schweitzer, and Toevs (1981 also analyze the effectiveness of immunized portfolios relative to the maturity bond portfolio. Barbell portfolios that consist of a maturity bond and a 20-year bond.…”

Section: Empirical Evidence On the Performance Of Alternative Interesmentioning

confidence: 99%

The Performance of Alternative Interest Rate Risk Measures and Immunization Strategies under a Heath-Jarrow-Morton Framework

Ağca

2005

J. Financ. Quant. Anal.

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“…4 2 For instance, Macaulay (1938) and Fisher and Weil (1971) assume additive shocks on the interest rates. Bierwag (1977), Bierwag et al (1981), Khang (1979), Chambers et al (1988), Prisman and Shores (1988), Prisman and Tian (1993), Paroush and Prisman (1997), and others assume other more general shocks. Cox et al (1979), Brennan and Schwartz (1983), Nelson and Schaefer (1983) and others study immunization strategies in equilibrium models of the term structure.…”

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When can you immunize a bond portfolio?

Balbás

Ibáñez

1998

Journal of Banking & Finance

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This paper presents a condition equivalent to the existence of a Riskless Shadow Asset that guarantees a minimum return when the asset prices are convex functions of interest rates or other state variables. We apply this lemma to immunize default free and option free coupon bonds and reach three main conclusions. First, we give a solution to an old puzzle: why do simple duration matching portfolios work well in empirical studies of immunization even though they are derived in a model inconsistent with equilibrium and shifts on the term structure of interest rates are not parallel, as as sumed? Second, we establish a clear distinction between the concepts of immunized and maxmin portfolios. Third, we develop a framework that includes the main results of this literature as special cases. Next, we present a new strategy of immunization that consists in matching duration and minimizing a new linear dispersion measure of immunization risk. Ó 1998 Elsevier Science B.V. All rights reserved.JEL classi®cation: G11

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“…Analogously to the section 7, we will assume that (1) this shift is instantaneously after the acquisition of the portfolio, (2) there can be three types of shifts: a parallel shift and two alternative changes in the slope of the yield curve, and (3) the investment horizon is equal to six months. Table I shows the accumulated value obtained at the end of the investment horizon and the yield (in annual terms) provided by each bond when there is a parallel change in the yield curve.…”

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confidence: 99%

“…Immunization allows us to set up and manage a bond portfolio in such a way that this portfolio reaches a predetermined goal: to mimic a certain index, to guarantee a set of future payments 2 or to obtain a certain return. Generally speaking, the methodology used when immunizing a bond portfolio is based on equating the durations of this bond portfolio and the asset to be replicated.…”

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Risk Management under a Two-Factor Model of the Term Structure of Interest Rates

Moreno

1998

SSRN Journal

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Fixed-income markets have experienced, two decades ago, a great increase in the volatility of the assets which these markets deal with 1 . Because of that, the academics and, in general, the participants in these market have developed and implemented tools and techniques in order to manage the risk derived from interest rates. In general, the price of a bond portfolio is inuenced by many factors: the level and the volatility of the interest rates, changes in the shape of the yield curve, default probability and liquidity changes. In particular, we will consider default-free securities and deep and liquid markets. We will focus on two types of risk that depend on the changes that the yield curve can show: \Market risk". It is caused by changes in the level of the interest rates.Hence, this risk is associated to parallel changes (changes with similar size in all the maturities) in the yield curve.\Yield curve risk". It is derived from non-parallel changes, that is, changes in the shape of the yield curve. It can be decomposed into two terms:{ Changes in the slope: Changes in the short-term interest rates have dierent size in relation to changes in long-term interest rates. The slope of the yield curve decreases (increases) if the short-term interest rates change more (less) than interest rates corresponding to longer maturities. { Changes in the curvature: Changes in the extremes of the yield curve are similar but with dierent direction when compared to changes in intermediate maturities.

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The art of risk management in bond portfolios

Cited by 32 publications

References 0 publications

The Performance of Alternative Interest Rate Risk Measures and Immunization Strategies under a Heath-Jarrow-Morton Framework

The Performance of Alternative Interest Rate Risk Measures and Immunization Strategies under a Heath-Jarrow-Morton Framework

When can you immunize a bond portfolio?

Risk Management under a Two-Factor Model of the Term Structure of Interest Rates

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