Modern Multi-Factor Analysis of Bond Portfolios: Critical Implications for Hedging and Investing by Giovanni Barone Adesi & Nicola Carcano

Author:Giovanni Barone Adesi & Nicola Carcano
Language: eng
Format: epub
ISBN: 9781137564870
Publisher: Palgrave Macmillan
Published: 2016-03-08T16:00:00+00:00

where the symbols have the same meaning as in Equation (37.), but now refer to the S&P500 futures contract. In the next sub-sections, we show how to calculate the optimal weights for each strategy starting from this set of sensitivity equations and stochastic processes.

4.2.2Hedging through T-bond futures

In the case of this hedging strategy, the hedging portfolio is exclusively composed from T-bond futures. Accordingly, we set the number of the considered risk factors L also equal to four. Also, we assume that the dynamics of these risk factors are independent from each other; since we are going to identify these dynamics through PCA, this assumption is true by construction. Relying on Equations (36.) to (41.), the total unexpected return ψ provided by the combination of the bond and the hedging portfolio is:

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