Managing the Risks of Corporate Bond Portfolios: New Evidence in the Light of the
Sub‐Prime Crisis

54 Pages Posted: 11 Feb 2012  

Giovanni Barone-Adesi

Swiss Finance Institute at the University of Lugano; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Nicola Carcano

University of Lugano

Hakim Dall'O

Swiss Finance Institute at the University of Lugano

Date Written: February 1, 2012

Abstract

We consider modeling errors in the hedging of a portfolio composed from BBB‐rated bonds. By doing this, we open a new perspective to the debate on the relationship between corporate bonds and CDS spreads. We find that in ordinary times the added value of indexlinked credit derivatives is very limited: hedging portfolios including only T‐bond futures can reduce the variance by 80‐85%. This compares well to the maximum variance reduction of 50% reported by previous studies. On the contrary, in times of extraordinary volatility – such as the years 2008 and 2009 ‐ T‐bond futures would have been insufficient to successfully hedge the bond portfolio. However, including the 5‐year CDX contract would have only slightly improved the quality of hedging. This is consistent with the literature identifying an important non‐default component within corporate bond spreads. Our results encourage the offering of collateralized credit spread forwards as more effective hedging instruments than non‐collateralized CDS contracts.

Keywords: hedging, corporate bonds, model errors

JEL Classification: C51, G13, G32

Suggested Citation

Barone-Adesi, Giovanni and Carcano, Nicola and Dall'O, Hakim, Managing the Risks of Corporate Bond Portfolios: New Evidence in the Light of the Sub‐Prime Crisis (February 1, 2012). Swiss Finance Institute Research Paper No. 12-04. Available at SSRN: https://ssrn.com/abstract=2002040 or http://dx.doi.org/10.2139/ssrn.2002040

Giovanni Barone-Adesi (Contact Author)

Swiss Finance Institute at the University of Lugano ( email )

Via Buffi 13
CH-6904 Lugano
Switzerland
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Nicola Carcano

University of Lugano ( email )

Via Sole 14
Ruvigliana, Ticino 6900
Switzerland

Hakim Dall'O

Swiss Finance Institute at the University of Lugano ( email )

Via Buffi 13
Lugano, CH-6900
Switzerland
+41 58 666 4497 (Phone)

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