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Immunizing a Marked-to-Model Obligation with Marked-to-Market Financial Instruments

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  • Victor Lapshin

    (National Research University Higher School of Economics)

Abstract

The traditional bond portfolio immunization problem statement assumes that both the obligation and the immunizing portfolio belong to the same liquidity class, i.e. both are valued either at their respective observed market prices (mark-to-market) or via the sum of discounted cash flows (mark-to-model). However, it is customary to hedge an obligation for which there is no liquid market with relatively liquid market instruments. We propose a new problem formulation, where the obligation is marked to a model via discounted cash flows while the immunizing portfolio is marked to the market via real observed prices. We solve the immunization problem in this new formulation and test the performance of its solution. The new approach performs better within the new problem formulation while the traditional approach performs better within the classical problem formulation. The differences are more pronounced if the number of actively traded bonds is small.

Suggested Citation

  • Victor Lapshin, 2021. "Immunizing a Marked-to-Model Obligation with Marked-to-Market Financial Instruments," HSE Working papers WP BRP 84/FE/2021, National Research University Higher School of Economics.
    • Handle: RePEc:hig:wpaper:84/fe/2021
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    References listed on IDEAS

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    More about this item

    Keywords

    immunization; mark-to-market; mark-to-model; empirical test; bond portfolio;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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