scholarly journals Robust long-term interest rate risk hedging in incomplete bond markets

2020 ◽  
pp. 1-28
Author(s):  
Sally Shen ◽  
Antoon Pelsser ◽  
Peter Schotman
Keyword(s):  
Yield Curve ◽  
Interest Rate Risk ◽  
Bond Markets ◽  
Risk Hedging ◽  
Hedging Portfolio ◽  
Robust Least Squares ◽  
Rate Environment ◽  
Market Consistent Valuation ◽  
Pension Liabilities

Abstract Pricing ultra-long-dated pension liabilities under the market-consistent valuation is challenged by the scarcity of the long-term market instruments that match or exceed the terms of pension liabilities. We develop a robust self-financing hedging strategy which adopts a min–max expected shortfall hedging criterion to replicate the long-dated liabilities for agents who fear parameter misspecification. We introduce a backward robust least squares Monte Carlo method to solve this dynamic robust optimization problem. We find that both naive and robust optimal portfolios depend on the hedging horizon and the current funding ratio. The robust policy suggests taking more risk when the current funding ratio is low. The yield curve constructed by the robust dynamic hedging portfolio is always lower than the naive one but is higher than the model-based yield curve in a low-rate environment.

Inter-dependencies among Asian bond markets

2017 ◽  
Vol 34 (4) ◽  
pp. 485-505 ◽  
Author(s):  
Sowmya Subramaniam ◽  
Krishna P. Prasanna
Keyword(s):  
Term Structure ◽  
Yield Curve ◽  
Factor Model ◽  
Dynamic Factor ◽  
Bond Markets ◽  
Content Type ◽  
Monetary Authorities ◽  
Asian Economies ◽  
Regional Factors

Purpose The purpose of the paper is to investigate the global and regional influences on the domestic term structure of nine Asian economies. Design/methodology/approach The dynamic Nelson Siegel model was used to extract the latent factors of a country’s yield curve movements in a state-space framework using the Kalman filter. The global and regional factors of the yield curve were extracted using the dynamic factor model. Further, the Bayesian inference of Gibbs sampling approach was used to identify the influence of global and regional factors on the domestic yield curve. Findings The results suggest that financial integration does not reduce the control of monetary authorities on the front end of the yield curve, and long-term interest rate is the potential transmission channel through which the contagion of the financial crisis spreads. Practical implications The results of this study would help the monetary authorities to understand the efficacy of the monetary policy transmission mechanism. It also offers the global investors diversification opportunities for investing in the Asian bond markets. Originality/value It is one of the earliest attempts to capture the global and regional yield curve movements and their impact on the emerging Asian economies yield curve. It contributes to literature by identifying the linkages in the long-term factor that is the potential channel through which crisis spreads.

scholarly journals Take the Short Route: Equilibrium Default and Debt Maturity

Econometrica ◽  
2019 ◽  
Vol 87 (2) ◽  
pp. 423-462 ◽  
Author(s):  
Mark Aguiar ◽  
Manuel Amador ◽  
Hugo Hopenhayn ◽  
Iván Werning
Keyword(s):  
Sovereign Debt ◽  
Yield Curve ◽  
Debt Management ◽  
Limited Commitment ◽  
Bond Markets ◽  
Short Term ◽  
Marginal Costs ◽  
Wide Range ◽  
Debt Default

We study the interactions between sovereign debt default and maturity choice in a setting with limited commitment for repayment as well as future debt issuances. Our main finding is that, under a wide range of conditions, the sovereign should, as long as default is not preferable, remain passive in long‐term bond markets, making payments and retiring long‐term bonds as they mature but never actively issuing or buying back such bonds. The only active debt‐management margin is the short‐term bond market. We show that any attempt to manipulate the existing maturity profile of outstanding long‐term bonds generates losses, as bond prices move against the sovereign. Our results hold regardless of the shape of the yield curve. The yield curve captures the average costs of financing at different maturities but is misleading regarding the marginal costs.

scholarly journals Hedging Long-Term Liabilities*

2020 ◽  
Author(s):  
Rogier Quaedvlieg ◽  
Peter Schotman
Keyword(s):  
Yield Curve ◽  
Mean Squared Error ◽  
Factor Model ◽  
Interest Rate Risk ◽  
Time Varying ◽  
Hedging Strategy ◽  
Factor Loadings ◽  
Life Insurers ◽  
Five Factors

Abstract Pension funds and life insurers face interest rate risk arising from the duration mismatch of their assets and liabilities. With the aim of hedging long-term liabilities, we estimate variations of a Nelson–Siegel model using swap returns with maturities up to 50 years. We consider versions with three and five factors, as well as constant and time-varying factor loadings. We find that we need either five factors or time-varying factor loadings in the three-factor model to accommodate the long end of the yield curve. The resulting factor hedge portfolios perform poorly due to strong multicollinearity of the factor loadings in the long end, and are easily beaten by a robust, near Mean-Squared-Error- optimal, hedging strategy that concentrates its weight on the longest available liquid bond.

scholarly journals Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement

2021 ◽  
Author(s):  
Jens H. E. Christensen ◽  
Jose A. Lopez ◽  
Paul L. Mussche
Keyword(s):  
Financial Risk ◽  
Stress Testing ◽  
Yield Curve ◽  
Interest Rate Risk ◽  
Insurance Companies ◽  
Fixed Income ◽  
Bond Yields ◽  
Simple Tool ◽  
Interest Rate Risk Management

Insurance companies and pension funds have liabilities far into the future and typically well beyond the longest maturity bonds trading in fixed-income markets. Such long-lived liabilities still need to be discounted, and yield curve extrapolations based on the information in observed yields can be used. We use dynamic Nelson-Siegel (DNS) yield curve models to extrapolate risk-free yield curves for Switzerland and several countries. We find slight biases in extrapolated long bond yields of just a few basis points. In addition, the DNS model allows the generation of useful financial risk metrics, such as ranges of possible yield outcomes over projection horizons commonly used for stress-testing purposes. Therefore, we recommend using DNS models as a simple tool for generating extrapolated yields for long-term interest rate risk management. This paper was accepted by Kay Giesecke, finance.

scholarly journals Riding the Yield Curve

2020 ◽  
Vol 20 (53) ◽  
Author(s):  
Ralph Chami ◽  
Thomas Cosimano ◽  
Celine Rochon ◽  
Julieta Yung
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Risk Taking ◽  
Yield Curve ◽  
Interest Rate Risk ◽  
Risk Capital ◽  
Hedging Strategies ◽  
Rate Risk ◽  
Rate Environment ◽  
Changes In Risk

Investors seek to hedge against interest rate risk by taking long or short positions on bonds of different maturities. We study changes in risk taking behavior in a low interest rate environment by estimating a market stochastic discount factor that is non-linear and therefore consistent with the empirical properties of cashflow valuations identified in the literature. We provide evidence that non-linearities arise from hedging strategies of investors exposed to interest rate risk. Capital losses are amplified when interest rates increase and risk averse investors have taken positions on instruments with longer maturity, expecting instead interest rates to revert back to their historical average.

scholarly journals International Evidence on Extending Sovereign Debt Maturities

2021 ◽  
pp. 1.000-30.000
Author(s):  
Jens H. E. Christensen ◽  
◽  
Jose A Lopez ◽  
Paul Mussche
Keyword(s):  
Asset Management ◽  
Sovereign Debt ◽  
Yield Curve ◽  
Debt Management ◽  
Bond Markets ◽  
Foreign Government ◽  
Treasury Bond ◽  
Government Bond Markets ◽  
Dynamic Yield

Portfolio diversification is as important to debt management as it is to asset management. In this paper, we focus on diversification of sovereign debt issuance by examining the extension of the maximum maturity of issued debt. In particular, we examine the potential costs to the U.S. Treasury of introducing 50-year bonds as a financing option. Based on evidence from foreign government bond markets with such long-term debt, our results suggest that a 50-year Treasury bond would likely trade at an average yield that is at most 20 basis points above that of a 30-year bond. Our results based on extrapolations from a dynamic yield curve model using just U.S. Treasury yields are similar.

A MIXED BOND AND EQUITY FUND MODEL FOR THE VALUATION OF VARIABLE ANNUITIES

2020 ◽  
pp. 1-29
Author(s):  
Maciej Augustyniak ◽  
Frédéric Godin ◽  
Emmanuel Hamel
Keyword(s):  
Yield Curve ◽  
Fixed Income ◽  
Equity Fund ◽  
Basis Risk ◽  
Substantial Impact ◽  
Equity Funds ◽  
Rate Environment ◽  
Portfolio Return ◽  
Fund Return

Abstract Variable annuity (VA) policies are typically issued on mutual funds invested in both fixed income and equity asset classes. However, due to the lack of specialized models to represent the dynamics of fixed income fund returns, the literature has primarily focused on studying long-term investment guarantees on single-asset equity funds. This article develops a mixed bond and equity fund model in which the fund return is linked to movements of the yield curve. Theoretical motivation for our proposed specification is provided through an analogy with a portfolio of rolling horizon bonds. Moreover, basis risk between the portfolio return and its risk drivers is naturally incorporated into our framework. Numerical results show that the fit of our model to Canadian VA data is adequate. Finally, the valuation of VAs is illustrated and it is found that the prevailing interest rate environment can have a substantial impact on guarantee costs.

scholarly journals Immunization Strategies for Funding Multiple Inflation-Linked Retirement Income Benefits

Risks ◽  
2021 ◽  
Vol 9 (4) ◽  
pp. 60
Author(s):  
Cláudia Simões ◽  
Luís Oliveira ◽  
Jorge M. Bravo
Keyword(s):  
Interest Rate ◽  
Yield Curve ◽  
Risk Measure ◽  
Management Strategies ◽  
Interest Rate Risk ◽  
Insurance Companies ◽  
Retirement Income ◽  
Investment Strategies ◽  
Immunization Strategies ◽  
The Impact

Protecting against unexpected yield curve, inflation, and longevity shifts are some of the most critical issues institutional and private investors must solve when managing post-retirement income benefits. This paper empirically investigates the performance of alternative immunization strategies for funding targeted multiple liabilities that are fixed in timing but random in size (inflation-linked), i.e., that change stochastically according to consumer price or wage level indexes. The immunization procedure is based on a targeted minimax strategy considering the M-Absolute as the interest rate risk measure. We investigate to what extent the inflation-hedging properties of ILBs in asset liability management strategies targeted to immunize multiple liabilities of random size are superior to that of nominal bonds. We use two alternative datasets comprising daily closing prices for U.S. Treasuries and U.S. inflation-linked bonds from 2000 to 2018. The immunization performance is tested over 3-year and 5-year investment horizons, uses real and not simulated bond data and takes into consideration the impact of transaction costs in the performance of immunization strategies and in the selection of optimal investment strategies. The results show that the multiple liability immunization strategy using inflation-linked bonds outperforms the equivalent strategy using nominal bonds and is robust even in a nearly zero interest rate scenario. These results have important implications in the design and structuring of ALM liability-driven investment strategies, particularly for retirement income providers such as pension schemes or life insurance companies.

Sign in / Sign up

Export Citation Format

Share Document