Fixed-Income Portfolio Analytics: A Practical Guide to Implementing, Monitoring and Understanding Fixed-Income Portfolios

559 Pages·2015·16.22 MB·English

by  David Jamieson Bolder (auth.)

David Jamieson Bolder
Fixed-Income
Portfolio
Analytics
A Practical Guide to Implementing,
Monitoring and Understanding
Fixed-Income Portfolios
Fixed-Income Portfolio Analytics

David Jamieson Bolder
Fixed-Income Portfolio
Analytics
A Practical Guide to Implementing,
Monitoring and Understanding
Fixed-Income Portfolios
123
DavidJamiesonBolder
BankforInternationalSettlements
Basel
Switzerland
ISBN978-3-319-12666-1 ISBN978-3-319-12667-8(eBook)
DOI10.1007/978-3-319-12667-8
SpringerChamHeidelbergNewYorkDordrechtLondon
LibraryofCongressControlNumber:2015930328
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ÀNancy, la plusbellesaisondemavie

Foreword
Global fixed-income markets are enormous and growing. Trillions of dollars in
numerous currencies are invested in these markets by a broad range of investors
including pension funds, insurance companies, commercialbanks, corporate trea-
suries, endowments, sovereign-wealth funds, and central-bank reserve managers.
Eachoftheseinvestorsallocatessignificantresourcestowardsevaluating,monitor-
ing,andunderstandingtheday-to-dayexposures,performance,andrisksassociated
with the underlying market risk factors found in their portfolios. It is precisely
this type of careful attention by individual investors that leads to liquid, well-
functioning,andefficientmarkets.
Quantitativetoolsare an importantaspectof this ongoingoversightand imple-
mentationoffixed-incomeportfoliostrategies.Useofquantitativemodels,however,
requires both expertise and caution. Models can be powerful tools for dealing
withtheuncertaintyinfixed-incomemarkets,butsincetheyareonlymathematical
simplifications of a complex reality, they can also go wrong. This book, written
by David Bolder, a member of the staff in the Banking Department at the Bank
for International Settlements (BIS), is written with this point firmly in mind. It
doesnotprovidea prescriptivesolutionto fixed-incomeanalytics,butrathertakes
asuggestiveapproach.Inotherwords,insteadoftellingyouwhatyoushoulddo,it
indicatestechniquesthatyoumightwantto consider,examinefurther,or possibly
implement.Moreover,itconsistentlytriestoofferalternatives—whichmayperform
better or worse under different sets of circumstances—for any given element of
analysis. True quantitative expertise is based on the mastery of a wide range
of techniques, where the underlying approaches are developed from alternative
perspectives. This is an important element of the BIS philosophy and one of the
centraltenetsofthisbook.
This book simultaneously places a high value on the ongoing validation of
thesequantitativemodels.Chapters8and12areparticularlyusefulinthisrespect,
because they investigate a range of techniques for gauging the accuracy and
robustness of one’s fixed-income performance and risk measures, respectively.
Considering alternative models is always essential, but outlining, in advance, a
frameworkforevaluatingtherobustnessofthesemodelsisalsocritical.
vii
viii Foreword
Whydoesthismatter?Quantitative-basedapproaches,suchasthosepresentedin
thisbook,necessarilyinvolveassumptionsandapproximations.Theseassumptions
will not always hold, nor will the approximationsalways be good. Realizing this
factaboutquantitativemodellingisimportant.Prudentfixed-incomemanagement,
therefore, also requires regular evaluation of one’s model results with realized
marketoutcomes—oftenthisistermedback-testingormodelvalidation.Thisbook
wiselybuildsthisconceptintoitsoverallquantitativeframework.
Putting these ideas into the public domain, an approach that is also consistent
with the mandate of the BIS, is another way to assess the usefulness and validity
of the quantitative approaches suggested in this book. Books are written to share
knowledge,suggestideas,andcreatediscussion.Suchadiscussioncanonlypropel
thefixed-incomeinvestmentcommunityforwardtobetter,morecomplete,andmore
robustquantitativemethods.
In summary,noquantitativemodelis perfect.Facedwith the complexityofin-
vestingsizeableamountsofmoneyinfixed-incomemarkets,quantitativetechniques
arenonethelessnecessaryandusefulforabroadspectrumofinstitutions.Focusing
on a range of alternative techniques, making model validation a central part of
one’sframework,andactivelyseekingfeedbackfromtheacademicandpractitioner
communityfoster both a better understandingof one’smodelsand the underlying
markets. It also ensures that these models continue to be useful to fixed-income
investors. This book’s commitmentto these principles makes me confidentthat it
willbeavaluablecontributiontotheliterature.
Basel,Switzerland JaimeCaruana
September2014
Preface
Ajourneyofathousandmilesmustbeginwithasinglestep.
LaoTsu
Thefirststepinthecreationofthisbookwasthein-housedevelopmentofasoftware
application. The objective of this application was to provide decision-support
analyticstoagroupofportfoliomanagers.Decisionsupportmeans,inthiscontext,
the comparison of portfoliosalong a wide range of dimensions, the simulation of
portfolio trades, the computationand attribution of risk and performance,and the
provisionof some optimizationtools. We came, over the course of the project, to
describethiscollectionofmethodsandtechniquesasportfolioanalytics.
The portfolios in question were, and still are, comprised of a relatively wide
range of high-credit fixed-income instruments including principally sovereign,
supranational, agency, and highly rated corporate bonds. The portfolios also in-
cluded a range of ancillary instruments such as foreign-exchange swaps, bond
and rate futures, inflation-linked bonds, and interest-rate swaps. In other words,
these portfolioshold the typical fixed-incomeinstrumentsfound in the tool-kitof
a reserve-portfoliomanager in a central bank, a sovereign-wealthfund, a pension
fund,aninsurancecompany,anendowment,oraninternationalinstitution.
Whenonesetsouttobuildsuchasystem,thefirststepinvolvestheestablishment
of a consistent framework for the classification, comparison, and analysis of
different portfolios relative to their benchmark. Such a framework necessarily
involves taking explicit decisions and making assumptions about the treatment of
a wide rangeof instruments.I foundthis task to be particularlychallenginggiven
therelativedearthofdetailedreferencebooksdescribingmethodsforfixed-income
portfolioanalytics—therewerereferencesonfixed-incomerisk,performance,and
exposure, but relatively little combining them in a single setting. The learning
curve was steep, but the reward was an in-depth and practical understanding of
a number of related ideas that are reasonably well described by the term, fixed-
income portfolio analytics. Given the nature and mandate of my employer—the
BankofInternationalSettlements(BIS),whichisaninternationalinstitutionserving
global central banks—it was naturally decided to share this knowledge with our
ix