Alternative Models For Hedging Yield Curve Risk: An Empirical Comparison
AbstractWe develop alternative models for hedging yield curve risk and test them by hedging US Treasury bond portfolios through note/bond futures. We show that traditional implementations of models based on principal component analysis, duration vectors and key rate duration lead to high exposure to model errors and to sizable transaction costs, thus lowering the hedging quality. Also, this quality varies from one test case to the other, so that a clear ranking of the models is not possible. We show that accounting for the variance of modeling errors substantially reduces both hedging errors and transaction costs for all considered models. Also, this allows to clearly rank these models: error-adjusted principal component analysis systematically and significantly outperforms alternative models
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Bibliographic InfoPaper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 10-31.
Length: 38 pages
Date of creation: Jun 2010
Date of revision:
Yield Curve Risk; Interest Rate Risk; Immunization; Hedging;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
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