Improving Interest Rate Risk Hedging Strategies through Regularization. Issue 4 (2nd October 2022)

• Record Type: Journal Article
• Authors: Mantilla-Garcia, Daniel; Martellini, Lionel; Milhau, Vincent; Ramirez-Garrido, Hector Enrique
• Is Part Of: Financial analysts journal. Volume 78:Issue 4(2022)
• Page Start: 18
• Page End: 36
• Publication Date: 2022-10-02
• Subjects: interest rate hedging -- pension liability-hedging -- robust bond portfolio immunization; Investment analysis -- Periodicals; Investment analysis; HW_FM; Periodicals; Electronic journals; 332.6
• DOI: 10.1080/0015198X.2022.2095193
• Languages: English
• ISSNs: 0015-198X

Abstract

Abstract: The effectiveness of duration and convexity hedging strategies deteriorates in the presence of non-parallel shifts of the yield curve. In the absence of appropriate constraints, the extension of these strategies accounting for changes in the shape of the yield curve generates unstable weights and extreme leverage, leading to poor out-of-sample hedging performance. To address this conundrum, we recast the bond portfolio immunization problem as a multifactor optimization program with leverage constraints and weight regularization. These regularized immunization strategies offer a robust improvement in hedging performance and are particularly well-suited to secure future cash flow needs such as pension liabilities.