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A Factor Allocation Approach to Optimal Bond Portfolio

  • Keita Nakayama

    (Graduate school of Economics, University of Tokyo)

  • Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

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    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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    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. Hua He, 2000. "Modeling Term Structures of Swap Spreads," Yale School of Management Working Papers ysm150, Yale School of Management, revised 01 Mar 2001.
    2. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    3. 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).
    4. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
    5. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-92.
    6. 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.
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