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Hedging European government bond portfolios during the recent sovereign debt crisis

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  • Bessler, Wolfgang
  • Wolff, Dominik

Abstract

The sovereign debt crisis challenged investors in European government bonds to deal with volatile interest rate spreads. For managing sovereign risk, “Eurex” introduced futures contracts on Italian government bonds reflecting risks of lower rated countries. We analyze hedging strategies for bond portfolios with futures on German and Italian government bonds before and during the sovereign debt crisis and evaluate their out-of-sample hedging effectiveness. Before the crisis, German futures were efficient instruments for hedging government bond portfolios, but during the crisis, a composite hedge combining German and Italian futures was superior. Allocating bonds to high and low sovereign risk-buckets and hedging these buckets individually further enhanced the hedging efficiency.

Suggested Citation

  • 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.
  • Handle: RePEc:eee:intfin:v:33:y:2014:i:c:p:379-399
    DOI: 10.1016/j.intfin.2014.08.006
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    More about this item

    Keywords

    G01; G12; G13; G15; Sovereign debt crisis; Fixed income securities; Bond portfolio management; Interest rate futures; Hedge ratio; Hedging effectiveness;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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