Managing the Risks of Corporate Bond Portfolios: New Evidence in the Light of the Sub-Prime Crisis

Giovanni Barone-Adesi, Nicola Carcano and Hakim Dall'O
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Giovanni Barone-Adesi: Swiss Finance Institute, University of Lugano, and Ecole Polytechnique Fédérale de Lausanne
Nicola Carcano: University of Lugano
Hakim Dall'O: Swiss Finance Institute and University of Lugano

No 12-04, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We consider modeling errors in the hedging of a portfolio composed from BBB‐rated bonds. By doing this, we open a new perspective to the debate on the relationship between corporate bonds and CDS spreads. We find that in ordinary times the added value of indexlinked credit derivatives is very limited: hedging portfolios including only T-bond futures can reduce the variance by 80-85%. This compares well to the maximum variance reduction of 50% reported by previous studies. On the contrary, in times of extraordinary volatility – such as the years 2008 and 2009 - T-bond futures would have been insufficient to successfully hedge the bond portfolio. However, including the 5-year CDX contract would have only slightly improved the quality of hedging. This is consistent with the literature identifying an important non‐default component within corporate bond spreads. Our results encourage the offering of collateralized credit spread forwards as more effective hedging instruments than non‐collateralized CDS contracts.

Keywords: hedging; corporate bonds; model errors (search for similar items in EconPapers)
JEL-codes: C51 G13 G32 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2012-02
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1204

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