Alternative models for hedging yield curve risk: An empirical comparison

Nicola Carcano and Hakim Dall'O

Journal of Banking & Finance, 2011, vol. 35, issue 11, 2991-3000

Abstract: We test alternative models of yield curve risk by hedging US Treasury bond portfolios through note/bond futures. We show that traditional implementations of models based on principal component analysis, duration vectors and key rate duration lead to high exposure to model errors and to sizable transaction costs, thus lowering the hedging quality. Also, this quality randomly varies from one model and hedging problem to the other. We show that accounting for the variance of modeling errors substantially reduces both hedging errors and transaction costs for all considered models. Additionally, it leads to much more stable weights in the hedging portfolios and - as a result - to more homogeneous hedging quality. On this basis, error-adjusted principal component analysis is found to systematically and significantly outperform alternative models.

Keywords: Yield; curve; risk; Interest; rate; risk; Immunization; Hedging (search for similar items in EconPapers)
Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0378426611001312
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:35:y:2011:i:11:p:2991-3000

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().