Written on 26 August 2022.
Daniel Mantilla-Garcia, EDHEC PhD (2012), Research Associate, EDHEC-Risk Institute, Assistant Professor of Finance, Universidad de Los Andes
Lionel Martellini, Professor of Finance, EDHEC Business School, Director, EDHEC-Risk Institute
Vincent Milhau, Research Director, EDHEC-Risk Institute
Hector Enrique Ramirez-Garrido, Research Assistant, Universidad de Los Andes
The effectiveness of duration and convexity hedging strategies deteriorates in the presence of non-parallel shifts of the yield curve. In the absence of appropriate constraints, the extension of these strategies accounting for changes in the shape of the yield curve generates unstable weights and extreme leverage, leading to poor out-of-sample hedging performance.
To address this conundrum, authors recast the bond portfolio immunization problem as a multifactor optimization program with leverage constraints and weight regularization. These regularized immunization strategies offer a robust improvement in hedging performance and are particularly well-suited to secure future cash flow needs such as pension liabilities.
“An important application of what we do in the paper, is to better manage the risk of pension funds, particularly, to construct more robust pension liability hedging portfolios” says Daniel Mantilla, EDHEC-Risk Institute Associate Researcher and PhD, EDHEC Business School.
#interestratehedging #pensionliabilityhedging #robustbondportfolioimmunization