Hostname: page-component-848d4c4894-v5vhk Total loading time: 0 Render date: 2024-07-07T01:00:07.783Z Has data issue: false hasContentIssue false

The Performance of Alternative Interest Rate Risk Measures and Immunization Strategies under a Heath-Jarrow-Morton Framework

Published online by Cambridge University Press:  06 April 2009

Senay Agca
Affiliation:
sagca@gwu.edu, George Washington University, 2023 G St NW, Lisner Hall 540G, Washington, DC 20052.

Abstract

Using a Monte Carlo simulation, this study addresses the question of how traditional risk measures and immunization strategies perform when the term structure evolves in a Heath-Jarrow-Morton (1992) manner. The results suggest that, for immunization purposes, immunization strategies and portfolio formation strategies are more important than interest rate risk measures. The performance of immunization strategies depends more on the transaction costs and the holding period than on the risk measures. Moreover, the immunization performance of bullet and barbell portfolios is not very sensitive to interest rate risk measures.

Type
Research Article
Copyright
Copyright © School of Business Administration, University of Washington 2005

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Amin, K. L., and Morton, A.. “Implied Volatility Functions in Arbitrage Free Term Structure Models.” Journal of Financial Economics, 35 (1994), 141180.CrossRefGoogle Scholar
Amin, K. L., and Ng, V. K.. “Inferring Future Volatility from the Information in Implied Volatility in Eurodollar Options: A New Approach.” Review of Financial Studies, 10 (1997), 333367.CrossRefGoogle Scholar
Au, K. T., and Thurston, D. C.. “A New Class of Duration Measures.” Economics Letters, 47 (1995), 371375.CrossRefGoogle Scholar
Babbel, D. F. “Duration and the Term Structure of Interest Rate Volatility.” In Innovations in Bond Portfolio Management: Duration Analysis and Immunization, Kaufman, G. G., Bierwag, G. O., and Toevs, A., eds. Greenwich, CT: JAI Press (1983).Google Scholar
Bierwag, G. O.Duration and Interest Rate Risk for a Binomial Interest Rate Stochastic Process.” Canadian Journal of Administrative Sciences, 17 (2000), 115125.CrossRefGoogle Scholar
Bierwag, G. O.; Kaufman, G. G.; Schweitzer, R.; and Toevs, A.. “The Art of Risk Management in Bond Portfolios.” Journal of Portfolio Management (Spring 1981), 2736.CrossRefGoogle Scholar
Bierwag, G. O.; Kaufman, G. G.; and Toevs, A.. “Immunization Strategies for Funding Multiple Liabilities.” Journal of Financial and Quantitative Analysis, 18 (1983), 113124.CrossRefGoogle Scholar
Bliss, R.Testing Term Structure Estimation Methods.” Advances in Futures and Options Research, 9 (1997), 197231.Google Scholar
Boyle, P.; Broadie, M.; and Glasserman, P.. “Monte Carlo Methods for Security Pricing.” Journal of Economic Dynamics and Control, 21 (1997), 12671321.CrossRefGoogle Scholar
Brennan, M. J., and Schwartz, E. S.. “Duration, Bond Pricing, and Portfolio Management.” In Innovations in Bond Portfolio Management: Duration Analysis and Immunization, Kaufman, G. G., Bierwag, G. O., and Toevs, A., eds. Greenwich, CT: JAI Press (1983).Google Scholar
Carcano, N., and Foresi, S.. “Hedging Against Interest Rate Risk: Reconsidering Volatility-Adjusted Immunization.” Journal of Banking and Finance, 21 (1997), 127141.CrossRefGoogle Scholar
Chapman, D. A., and Pearson, N. D.. “Recent Advances in Estimating Term-Structure Models.” Financial Analysts Journal, 57 (07/08 2001), 7795.CrossRefGoogle Scholar
Cox, J.; Ingersoll, J. E.; and Ross, S. A.. “Duration and Measurement of Basis Risk.” Journal of Business, 52 (1979), 5761.Google Scholar
Duffie, D., and Glynn, P.. “Efficient Monte Carlo Simulation of Security Prices.” Annals of Applied Probability, 5 (1995), 897905.CrossRefGoogle Scholar
Duanmu, Z. “First Passage Time Density Approach to Pricing Barrier Options and Monte Carlo Simulation of HJM Interest Rate Model.” Ph.D. Diss., Cornell Univ. (1994).Google Scholar
Fama, E., and Bliss, R.. “The Information in Long-Maturity Forward Rates.” American Economic Review, 77 (1987), 680692.Google Scholar
Fisher, L., and Weil, R. L.. “Coping with the Risk of Market Rate Fluctuations: Returns to Bondholders from Naive and Optimal Strategies.” Journal of Business, 44 (1971), 408431.CrossRefGoogle Scholar
Fleming, M., and Sarkar, A.. “Liquidity in U.S. Treasury Spot and Futures Markets.” In Market Liquidity: Research Findings and Selected Policy Implications. Report No. 11 by Committee on the Global Financial System, Bank of International Settlements (1999).Google Scholar
Fruhwirth, M.The Heath-Jarrow-Morton Duration and Convexity: A Generalized Approach.” International Journal of Theoretical and Applied Finance, 5 (2002), 695700.CrossRefGoogle Scholar
Gultekin, N. B., and Rogalski, R. J.. “Alternative Duration Specifications and the Measurement of Basis Risk: Empirical Tests.” Journal of Business, 57 (1984), 241264.CrossRefGoogle Scholar
Hasan, I., and Sarkar, S.. “Banks' Option to Lend, Interest Rate Sensitivity, and Credit Availability.” Review of Derivatives Research, 5 (2002), 213250.CrossRefGoogle Scholar
Heath, D.; Jarrow, R.; and Morton, A.. “Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation.” Econometrica, 60 (1992), 77105.CrossRefGoogle Scholar
Hicks, J. R.Value and Capital. Oxford, UK: Claderon Press (1939).Google Scholar
Ho, L.; Cadle, J.; and Theobald, M.. “Estimation and Hedging with a One-Factor Heath-Jarrow-Morton Model.” Journal of Derivatives (Summer 2001), 4961.CrossRefGoogle Scholar
Ho, T. S. Y., and Lee, S.. “Term Structure Movements and Pricing Interest Rate Contingent Claims.” Journal of Finance, 41 (1986), 10111029.CrossRefGoogle Scholar
Ilmanen, A.How Well Does Duration Measure Interest Rate Risk?Journal of Fixed Income (03 1992), 4351.CrossRefGoogle Scholar
Ilmanen, A. “Convexity Bias and the Yield Curve.” In Advanced Fixed-Income Valuation Tools, Jegadeesh, N. and Tuckman, B., eds. New York, NY: John Wiley & Sons, Inc. (2000).Google Scholar
James, J., and Webber, N.. Interest Rate Modelling. London, UK: John Wiley & Sons Ltd. (2000).Google Scholar
Jarrow, R. A.Modeling Interest Rate Securities and Interest Rate Options. New York, NY: McGraw-Hill Companies Inc. (1996).Google Scholar
Jeffrey, A.Duration, Convexity, and Higher Order Hedging (Revisited).” Working Paper, Yale Univ. (2000).Google Scholar
Kloeden, P. E., and Platen, E.. Numerical Solution of Stochastic Different Equations. New York, NY: Springer-Verlang (1992).CrossRefGoogle Scholar
L'Ecuyer, P.Good Parameters and Implementations for Combined Multiple Recursive Random Number Generators.” Operations Research, 47 (1999), 159164.CrossRefGoogle Scholar
Litterman, R., and Scheinkman, J.. “Common Factors Affecting Bond Returns.” Journal of Fixed Income, 3 (1991), 5461.CrossRefGoogle Scholar
Macaulay, F. R.Some Theoretical Problems Suggested by the Movements of Interest Rates, Bond Yields and Stock Prices in the United States since 1856. New York, NY: Columbia Univ. Press (1938).Google Scholar
Marsaglia, G., and Bray, T. A.. “A Convenient Method for Generating Random Variables.” SIAM Review, 6 (1964), 260264.CrossRefGoogle Scholar
McCulloch, J. H.An Estimate of Liquidity Premium.” Journal of Political Economy, 83 (1975), 95119.CrossRefGoogle Scholar
McCulloch, J. H., and Kwon, H.-C.. “U.S. Term Structure Data, 1947–1991.” Working Paper, Ohio State Univ. (1993).Google Scholar
Mercurio, F., and Moraleda, J. M.. “An Analytically Tractable Interest Rate Model with Humped Volatility.” European Journal of Operational Research, 120 (2000), 205214.CrossRefGoogle Scholar
Munk, C.Stochastic Duration and Fast Coupon Bond Option Pricing in Multi-Factor Models.” Review of Derivatives Research, 3 (1999), 157181.CrossRefGoogle Scholar
Nelson, J., and Schaefer, S.. “The Dynamics of the Term Structure and Alternative Immunization Strategies.” In Innovations in Bond Portfolio Management: Duration Analysis and Immunization, Kaufman, G. G., Bierwag, G. O., and Toevs, A., eds. Greenwich, CT: JAI Press (1983).Google Scholar
Nelson, B. L., and Schmeiser, B. W.. “Decomposition of Some Well-Known Variance Reduction Techniques.” Journal of Statistical and Computational Simulation, 23 (1986), 183209.CrossRefGoogle Scholar
Redington, F. M.Review of the Principle of Life-Office Valuation.” Journal of the Institute of Actuaries, 78 (1952), 286340.CrossRefGoogle Scholar
Rebonato, R.Interest Rate Option Models, 2nd ed. New York, NY: John Wiley & Sons (1998).Google Scholar
Samuelson, P. A.The Effects of Interest Rate Increases on the Banking System.” American Economic Review, 34 (1945), 1627.Google Scholar