Multifactor Models for Managing Interest Rate Risk

17 Pages Posted: 6 Sep 2008

See all articles by Sanjay K. Nawalkha

Sanjay K. Nawalkha

University of Massachusetts Amherst - Isenberg School of Management

Gloria M. Soto

University of Murcia - Faculty of Business and Economics

Date Written: September 6, 2008

Abstract

How do the managers of financial institutions hedge against the effects of non-parallel yield curve shifts? This paper addresses this important issue by reviewing the important findings in the area of interest rate risk management over the past two decades. We discuss four classes of models in the fixed income literature that deal with hedging the risk of large, non-parallel yield curve shifts. These models are given as M-Absolute/M-Square models, duration vector models, key rate duration models, and principal component duration models. These models can be used for designing various passive strategies such as portfolio immunization, bond index replication, and duration gap management; and hybrid strategies (i.e., active/passive) such as targeted yield curve shifts speculation (based on change in either the height, and/or the slope, and/or the curvature of the yield curve) and contingent immunization.

Keywords: interest rate, yield curve, fixed income, duration, immunization, portfolio strategy

JEL Classification: E43, G12

Suggested Citation

Nawalkha, Sanjay K. and Soto, Gloria M., Multifactor Models for Managing Interest Rate Risk (September 6, 2008). Available at SSRN: https://ssrn.com/abstract=1264282 or http://dx.doi.org/10.2139/ssrn.1264282

Sanjay K. Nawalkha

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States
413-687-2561 (Phone)

Gloria M. Soto (Contact Author)

University of Murcia - Faculty of Business and Economics ( email )

Spain

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