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A Factor Allocation Approach to Optimal Bond Portfolio

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  • Keita Nakayama

    (Graduate school of Economics, University of Tokyo)

  • Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

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    Abstract

    This paper proposes a new method to a bond portfolio problem in a multi-period setting. In particular, we apply a factor allocation approach to constructing the optimal bond portfolio in a class of multi-factor Gaussian yield curve models. In other words, we consider a bond portfolio problem in terms of a factors' allocation problem. Thus, we can obtain clear interpretation about the relation between the change in the shape of a yield curve and dynamic optimal strategy, which is usually hard to be obtained due to high correlations among individual bonds. We first present a closed form solution of the optimal bond portfolio in a class of the multi-factor Gaussian term structure model. Then, we investigate the effects of various changes in the term structure on the optimal portfolio strategy through series of comparative statics.

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2008/2008cf547.pdf
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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-547.

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    Length: 40 pages
    Date of creation: Mar 2008
    Date of revision:
    Handle: RePEc:tky:fseres:2008cf547

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    1. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    2. Korn, Olaf & Koziol, Christian, 2006. "Bond portfolio optimization: A risk-return approach," CFR Working Papers 06-03, University of Cologne, Centre for Financial Research (CFR).
    3. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
    4. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    5. Hua He, 2000. "Modeling Term Structures of Swap Spreads," Yale School of Management Working Papers ysm150, Yale School of Management, revised 01 Mar 2001.
    6. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-92.
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