Immunisation with consistent term structure dynamics

Session 2: Term Structure Modelling I

Abstract: We show that improved hedging of bond portfolios can be achieved by matching generalised durations that are parametrised according to a parsimonious yield curve shape which is dynamically consistent with a new term structure model with stochastic level, slope, and curvature factors. Performance deteriorates if matching basic durations, or generalised durations based on unrestricted factor models or dynamically inconsistent curve shapes. The dynamic consistency approach accommodates standard affine models as the special case in which locally deterministic factors are constant through time, corresponding to the intercept in the affine yield, but hedging performance deteriorates under this restriction.
(Based on joint work with D. Borup and J. Hansen.)