A0911
Title: Immunization with term structure dynamics
Authors: Jorge Wolfgang Hansen - Aarhus University and CREATES and the Danish Finance Institute (Denmark) [presenting]
Daniel Borup - Aarhus University (Denmark)
Bent Jesper Christensen - Aarhus University (Denmark)
Abstract: It is shown that improved hedging performance of bond portfolios can be obtained by exploiting no-arbitrage and consistency restrictions on the interest rate dynamics rather than using purely cross-sectional approaches based on factor analysis or a parametrized yield curve shape. We also introduce a new term structure model involving three stochastically varying factors corresponding to level, slope, and curvature, which leads to a further improvement in hedging performance. A restricted version of this model belongs to the three-factor affine class. The evidence shows the importance of immunizing the factor contribution to hedging error variance contrary to balancing factor versus idiosyncratic contributions.
