Factor Investing in Fixed-Income – Defining and Exploiting Value in Sovereign Bond Markets

Value has been recognised as one of the most important factors for equities since the pioneering work by Fama and MacBeth (1973). In equities, the book-to-market value ratio has traditionally been ...

Author(s):

Jean-Michel Maeso

EDHEC-Risk Institute

Lionel Martellini

EDHEC-Risk Institute

Riccardo Rebonato

EDHEC-Risk Institute

Value has been recognised as one of the most important factors for equities since the pioneering work by Fama and MacBeth (1973). In equities, the book-to-market value ratio has traditionally been used as a proxy for the value factor. Natural as this choice is for this asset class, it is difficult to translate the concept of value to the fixed-income domain.

In this paper, “Factor Investing in Fixed-Income – Defining and Exploiting Value in Sovereign Bond Markets”, we propose a definition of value in Treasury bonds that, we believe, is more satisfactory than definitions found in the recent literature, and that allows statistically significant and economically relevant predictions of cross-sectional excess returns. Our value pricing factor exploits the differences between the market and the theoretical values of Treasury bonds, where the theoretical value is assessed using an economically-justifiable Gaussian dynamic term structure model. 

We show that the profitability of the strategy we build using our value signal is closely linked to Treasury market volatility, and we provide an explanation for this strong link using arguments similar to those that can be found in the recent literature on liquidity in Treasuries.

Type: EDHEC Publication
Date: le 27/06/2019
Research Cluster : Finance

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