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Managing the Risks of Corporate Bond Portfolios: New Evidence in the Light of the Sub-Prime Crisis

Author

Listed:
  • Giovanni Barone-Adesi

    (Swiss Finance Institute, University of Lugano, and Ecole Polytechnique Fédérale de Lausanne)

  • Nicola Carcano

    (University of Lugano)

  • Hakim Dall'O

    (Swiss Finance Institute and University of Lugano)

Abstract

We consider modeling errors in the hedging of a portfolio composed from BBB‐rated bonds. By doing this, we open a new perspective to the debate on the relationship between corporate bonds and CDS spreads. We find that in ordinary times the added value of indexlinked credit derivatives is very limited: hedging portfolios including only T-bond futures can reduce the variance by 80-85%. This compares well to the maximum variance reduction of 50% reported by previous studies. On the contrary, in times of extraordinary volatility – such as the years 2008 and 2009 - T-bond futures would have been insufficient to successfully hedge the bond portfolio. However, including the 5-year CDX contract would have only slightly improved the quality of hedging. This is consistent with the literature identifying an important non‐default component within corporate bond spreads. Our results encourage the offering of collateralized credit spread forwards as more effective hedging instruments than non‐collateralized CDS contracts.

Suggested Citation

  • Giovanni Barone-Adesi & Nicola Carcano & Hakim Dall'O, 2012. "Managing the Risks of Corporate Bond Portfolios: New Evidence in the Light of the Sub-Prime Crisis," Swiss Finance Institute Research Paper Series 12-04, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1204
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    File URL: http://ssrn.com/abstract=2002040
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    Cited by:

    1. Bessler, Wolfgang & Wolff, Dominik, 2014. "Hedging European government bond portfolios during the recent sovereign debt crisis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 33(C), pages 379-399.

    More about this item

    Keywords

    hedging; corporate bonds; model errors;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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