Pricing and Constructing International Government Bond Portfolios

This paper derives a stochastic discount factor for currency-hedged government bonds of developed markets by projecting returns onto the unconditional mean-variance efficient (UMVE) portfolio. Priced risks of international bonds differ fundamentally from those of currencies. The UMVE portfolio achieves a Sharpe ratio over twice the average of individual markets, with the market price of risk peaking during crises and periods with high inflation dispersion. While bond returns exhibit a strong factor structure, common sources of variation are only weakly connected to priced risks. Hedging unpriced risks in naive or factor-based strategies significantly improves Sharpe ratios, even under portfolio weight constraints.

Keywords: international government bond portfolios, bond risk premia, stochastic discount factor.

JEL Classification: G11, G12, G15.

Suggested Citation: Suggested Citation

Randl, Otto and Simion, Giorgia and Zechner, Josef, Pricing and Constructing International Government Bond Portfolios (February 3, 2024). Available at SSRN: https://ssrn.com/abstract=4021429 or http://dx.doi.org/10.2139/ssrn.4021429