A Factor Risk Model with Reference Returns for the Us Dollar and Japanese Yen Bond Markets

36 Pages Posted: 30 Jun 2006

See all articles by Carlos Bernadell

Carlos Bernadell

European Central Bank - Risk Management Division

Joachim Coche

European Central Bank - Risk Management Division

Ken Nyholm

European Central Bank (ECB)

Date Written: June 2006

Abstract

This paper develops a new methodology for simulating fixed-income return distributions. It is shown that a traditional factor risk model, when augmented with reference returns, is capable of generating visually consistent return distributions for a broad range of fixed income instruments such as government and nongovernment instruments in the US dollar and Japanese yen bond markets. The reference returns result from a regime-switching Nelson-Siegel yield curve model following Bernadell, Coche and Nyholm (2005). Empirical results are encouraging: simulated distributions exhibit most characteristics observed in the fixed income markets such as non-normal right-skewed distributions for short maturity instrument while instruments with longer maturity are closer to being normally distributed.

Keywords: Regime switching, scenario analysis, factor risk model

JEL Classification: C15, C32, C53, G11, G15

Suggested Citation

Bernadell, Carlos and Coche, Joachim and Nyholm, Ken, A Factor Risk Model with Reference Returns for the Us Dollar and Japanese Yen Bond Markets (June 2006). ECB Working Paper No. 641, Available at SSRN: https://ssrn.com/abstract=907309

Carlos Bernadell (Contact Author)

European Central Bank - Risk Management Division ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Joachim Coche

European Central Bank - Risk Management Division ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Ken Nyholm

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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