Attributing Returns and Optimising United States Swaps Portfolios Using an Intertemporally-Consistent and Arbitrage-Free Model of the Yield Curve
AbstractThis paper uses the volatility-adjusted orthonormalised Laguerre polynomial model of the yield curve (the VAO model) from Krippner (2005), an intertemporally-consistent and arbitrage-free version of the popular Nelson and Siegel (1987) model, to develop a multi-dimensional yield-curve-based risk framework for fixed interest portfolios. The VAO model is also used to identify relative value (i.e. potential excess returns) from the universe of securities that define the yield curve. In combination, these risk and return elements provide an intuitive framework for attributing portfolio returns ex-post, and for optimising portfolios ex-ante. The empirical applications are to six years of daily United States interest rate swap data. The first application shows that the main sources of fixed interest portfolio risk (i.e. unanticipated variability in ex-post returns) are first-order (‘duration’) effects from stochastic shifts in the level and shape of the yield curve; second-order (‘convexity’) effects and other contributions are immaterial. The second application shows that fixed interest portfolios optimised ex-ante using the VAO model risk/relative framework significantly outperform a naive evenly-weighted benchmark over time.
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Bibliographic InfoPaper provided by University of Waikato, Department of Economics in its series Working Papers in Economics with number 05/03.
Length: 39 pages
Date of creation: 11 Mar 2005
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yield curve; term structure; fixed interest securities; portfolio optimisation; interest rate swaps;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-03-20 (All new papers)
- NEP-FIN-2005-03-20 (Finance)
- NEP-FMK-2005-03-20 (Financial Markets)
- NEP-MAC-2005-03-20 (Macroeconomics)
- NEP-RMG-2005-03-20 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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