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Capturing the Correlations of Fixed-income Instruments

Author

Listed:
  • John M. Mulvey

    (Statistics and Operations Research, Princeton University, Princeton, New Jersey 08544)

  • Stavros A. Zenios

    (Operations and Information Management Department, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104)

Abstract

This paper develops a framework for managing portfolios of fixed income instruments based on traditional principles from the equities market, i.e., based on diversification. It shows, through an analysis of the high-yield bond market over the period 1987 to 1991, that fixed-income prices could be highly correlated. These correlations can be quantified and integrated, in a systematic way, in an asset/liability management framework. For vanishing fixed income securities, however, we cannot resort to statistical analysis of historical data in order to quantify correlations. The paper develops a forward-looking simulation procedure for capturing correlations. Applications are illustrated for examples from high-yield bonds and mortgage-backed securities. The superiority of the proposed approach over the traditional portfolio immunization techniques is demonstrated in the context of funding an insurance liability stream with mortgage instruments.

Suggested Citation

  • John M. Mulvey & Stavros A. Zenios, 1994. "Capturing the Correlations of Fixed-income Instruments," Management Science, INFORMS, vol. 40(10), pages 1329-1342, October.
    • Handle: RePEc:inm:ormnsc:v:40:y:1994:i:10:p:1329-1342
    DOI: 10.1287/mnsc.40.10.1329
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    Citations

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    Cited by:

    1. Jobst, Norbert J. & Zenios, Stavros A., 2005. "On the simulation of portfolios of interest rate and credit risk sensitive securities," European Journal of Operational Research, Elsevier, vol. 161(2), pages 298-324, March.
    2. Woong Bee Choi & Dongyeol Lee & Woo Chang Kim, 2021. "Extending the Scope of ALM to Social Investment: Investing in Population Growth to Enhance Sustainability of the Korean National Pension Service," Sustainability, MDPI, vol. 13(1), pages 1-14, January.
    3. Andrea Consiglio & Michele Tumminello & Stavros A. Zenios, 2018. "Pricing Sovereign Contingent Convertible Debt," Journal of Enterprising Culture (JEC), World Scientific Publishing Co. Pte. Ltd., vol. 21(08), pages 1-36, December.
    4. Andrea Beltratti & Andrea Consiglio & Stavros Zenios, 1999. "Scenario modeling for the management ofinternational bond portfolios," Annals of Operations Research, Springer, vol. 85(0), pages 227-247, January.
    5. Konno, Hiroshi & Kobayashi, Katsunari, 1997. "An integrated stock-bond portfolio optimization model," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1427-1444, June.
    6. Robert Ferstl & Alex Weissensteiner, 2010. "Cash management using multi-stage stochastic programming," Quantitative Finance, Taylor & Francis Journals, vol. 10(2), pages 209-219.
    7. Weissensteiner, Alex, 2010. "Using the Black-Derman-Toy interest rate model for portfolio optimization," European Journal of Operational Research, Elsevier, vol. 202(1), pages 175-181, April.
    8. Andrea Consiglio & Stavros A. Zenios, 1999. "Designing Portfolios of Financial Products via Integrated Simulation and Optimization Models," Operations Research, INFORMS, vol. 47(2), pages 195-208, April.
    9. Zenios, Stavros A. & Holmer, Martin R. & McKendall, Raymond & Vassiadou-Zeniou, Christiana, 1998. "Dynamic models for fixed-income portfolio management under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 22(10), pages 1517-1541, August.
    10. Vassiadou-Zeniou, Christiana & Zenios, Stavros A., 1996. "Robust optimization models for managing callable bond portfolios," European Journal of Operational Research, Elsevier, vol. 91(2), pages 264-273, June.
    11. Vladislav Kargin, 2002. "On Bond Portfolio Management," Papers math/0208130, arXiv.org, revised Mar 2003.
    12. Vladislav Kargin, 2003. "Portfolio Management for a Random Field of Bond Returns," Finance 0310007, University Library of Munich, Germany.
    13. Anas Yassine & Abdelmadjid Ibenrissoul, 2018. "The macroeconomics determinants of default of the borrowers: The case of Moroccan bank," Papers 1801.05770, arXiv.org, revised Mar 2018.
    14. Anas Yassine & Abdelmadjid Ibenrissoul & Nawal Snoussi & Zakaria Benjouid, 2017. "The macroeconomics determinants of default of the borrowers: The case of Moroccan bank [Les déterminants macroéconomiques de la défaillance des emprunteurs : Le cas d'une banque marocaine]," Working Papers hal-01683225, HAL.
    15. Robert Ferstl & Alex Weissensteiner, 2010. "Backtesting short-term treasury management strategies based on multi-stage stochastic programming," Journal of Asset Management, Palgrave Macmillan, vol. 11(2), pages 94-112, June.
    16. ManMohan S. Sodhi, 2005. "LP Modeling for Asset-Liability Management: A Survey of Choices and Simplifications," Operations Research, INFORMS, vol. 53(2), pages 181-196, April.
    17. Nick Georgiopoulos, 2020. "Liability-driven investments of life insurers under investment credit risk," Risk Management, Palgrave Macmillan, vol. 22(2), pages 83-107, June.
    18. Norbert Jobst & Stavros A. Zenios, 2001. "Extending Credit Risk (Pricing) Models for the Simulation of Portfolios of Interest Rate and Credit Risk Sensitive Securities," Center for Financial Institutions Working Papers 01-25, Wharton School Center for Financial Institutions, University of Pennsylvania.

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