Hedging the Interest Rate Risk of Brady Bonds

26 Pages Posted: 7 Nov 2008

See all articles by Boudoukh Jacob

Boudoukh Jacob

affiliation not provided to SSRN

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

Date Written: July 1996

Abstract

While there is significant interest in investing in Brady bonds, the source of attraction is often the exposure to sovereign risk (and its yield compensation), while the exposure to U.S. interest rate risk is a â¬Snecessary evilâ¬?. This paper addresses the problem of determining the interest rate sensitivity of Brady debt. WE show that the most relevant state variables in determining the duration of a Brady bond are U.S. interest rates and the bondâ¬"s strip spread. Motivated by the difficult of using structural models to price and hedge Brady debt, we provide a model-free approach to estimating the hedge ratio. Using our approach to hedge the Argentinian Par and Discount Brady bonds, we find that only a small fraction (15% or so) of the total risk is hedgeable, but our hedged portfolio exhibits little covariation with U.S. interest rates.

Suggested Citation

Jacob, Boudoukh and Whitelaw, Robert F., Hedging the Interest Rate Risk of Brady Bonds (July 1996). NYU Working Paper No. FIN-96-016. Available at SSRN: https://ssrn.com/abstract=1297117

Boudoukh Jacob (Contact Author)

affiliation not provided to SSRN

No Address Available

Robert F. Whitelaw

New York University ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0338 (Phone)
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National Bureau of Economic Research (NBER)

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