Classic and modern measures of risk in fixed-income portfolio optimization
Miguel Ángel Martín Mato
Purpose – Interest rate risk immunization is one of the key concerns for fixed income portfolio management. In recent years, the affluence of new risk measures has emphasized the importance of comparing them with the classic approaches. As a result, one question arises: what is the relation among classic risk measures (e.g. Macaulay duration, convexity, and dispersion) and other more recent risk measures (e.g. value-at-risk and conditional value-at-risk) as tools for the formation of an optimum investment portfolio? This article aims to discuss this issue. Design/methodology/approach – To enhance objectivity, an empirical study has been conducted on the US Treasury bonds market by means of the formation of different portfolios among a selected set of bonds with different maturities and structures. In addition, information about yields from the mid-1990s and early 2000s has been used to find the optimum portfolio compositions based on each alternative risk measure. Findings – The main finding of the study is that there is an absence of relationships between those portfolios optimized by classic measures and those optimized by modern measures. The results show how both types of risk measures lead to quite different portfolios. Practical implications – The behavior of modern risk measures has been examined, with the finding that, when VaR is used, the sensitivity of the optimal portfolio with respect to the level of confidence is too high. Finally, if CVaR is used, then the optimal portfolio is quite stable with respect to the confidence level. Originality/value – This is the first paper to compare classic and modern measures of interest rate risk in fixed income portfolios. It is of value to decision makers, experts, and economic researchers.
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