Portfolio selection strategy for fixed income markets with immunization on average

In this paper, we develop a portfolio optimization method to maximize the performance of a fixed income portfolio. To achieve this aim, we define a two-step optimization problem where we firstly manage the immunization risk and then we maximize the portfolio wealth in a reward–risk framework. In the first optimization step, we create funds of bonds with constant immunization measure over time, and we propose an innovative immunization measure for bond portfolio management that leads to a more flexible immunization approach and a better trade-off between reward and risk. In the second optimization step, maximizing two performance measures on these baskets of bonds we obtain portfolio strategies that consider different investors’ profiles. An empirical application to the US fixed income market during 2002–2012 period is provided. Applying the portfolio optimization method to different bond classes, we compare the results with an equity index. This ex-post analysis indicates the benefits of the proposed portfolio strategy in outperforming the benchmark and proves that capital flows to safer markets during crisis periods.

[1]  Svetlozar T. Rachev,et al.  VaR, CVaR and Time Rules with Elliptical and Asymmetric Stable Distributed Returns , 2017 .

[2]  Damiano Rossello,et al.  Beyond Sharpe ratio: Optimal asset allocation using different performance ratios , 2008 .

[3]  A. Müller,et al.  Comparison Methods for Stochastic Models and Risks , 2002 .

[4]  On the use of contingent claims in portfolio selection problems , 2014 .

[5]  Sergio Ortobelli Lozza,et al.  American and European Portfolio Selection Strategies: the Markovian Approach , 2009 .

[6]  Peter Ove Christensen,et al.  Duration, Convexity, and Time Value , 1994 .

[7]  Jacob Paroush,et al.  On the relative importance of duration constraints , 1997 .

[8]  M. Statman,et al.  The Diversification Puzzle , 2004 .

[9]  Daniele Toninelli,et al.  Set-Portfolio Selection with the Use of Market Stochastic Bounds , 2011 .

[10]  Modeling, estimation, and optimization of equity portfolios with heavy-tailed distributions , 2010 .

[11]  Stoyan V. Stoyanov,et al.  DESIRABLE PROPERTIES OF AN IDEAL RISK MEASURE IN PORTFOLIO THEORY , 2008 .

[12]  Richard Roll.  INVESTMENT DIVERSIFICATION AND BOND MATURITY , 1971 .

[13]  Claus Munk,et al.  Fixed Income Modelling , 2011 .

[14]  Stavros A. Zenios,et al.  Asset/liability management under uncertainty for fixed-income securities , 1995, Ann. Oper. Res..

[15]  E. Fama,et al.  Common risk factors in the returns on stocks and bonds , 1993 .

[16]  W. Sharpe.  The Sharpe Ratio , 1994 .

[17]  Pao Lun Cheng.  Optimum Bond Portfolio Selections , 1962 .

[18]  Stanislav Uryasev,et al.  Conditional Value-at-Risk for General Loss Distributions , 2002 .

[19]  I. Kondor,et al.  Noise sensitivity of portfolio selection under various risk measures , 2006, physics/0611027.

[20]  Stoyan V. Stoyanov,et al.  Different Approaches to Risk Estimation in Portfolio Theory , 2004 .

[21]  Philippe Artzner,et al.  Coherent Measures of Risk , 1999 .

[22]  G. Hübner,et al.  The (more than) 100 Ways to Measure Portfolio Performance: Part 2: Special Measures and Comparison , 2009 .

[23]  Tan Wang,et al.  Keynes Meets Markowitz: The Tradeoff between Familiarity and Diversification , 2009, Manag. Sci..

[24]  Lawrence Fisher,et al.  Coping with the Risk of Interest-Rate Fluctuations: Returns to Bondholders from Naive and Optimal Strategies , 1971 .

[25]  A. Balbás,et al.  Dispersion measures as immunization risk measures , 2002 .

[26]  Oldrich A. Vasicek.  An equilibrium characterization of the term structure , 1977 .

[27]  R. L. Weil.  Macaulay's Duration: An Appreciation , 1973 .

[28]  Svetlozar T. Rachev,et al.  Phi-alpha optimal portfolios and Extreme Risk Management , 2003 .

[29]  Frank J. Fabozzi,et al.  Robust portfolios: contributions from operations research and finance , 2010, Ann. Oper. Res..

[30]  F. Fabozzi.  Duration, Convexity, and Other Bond Risk Measures , 1999 .

[31]  Oldrich A Vasicek,et al.  A Risk Minimizing Strategy for Portfolio Immunization , 1984 .

[32]  F. Fabozzi.  The Handbook of Fixed Income Securities , 1983 .

[33]  M. D. Felice.  Immunization Theory: An Actuarial Perspective on Asset-Liability Management , 2000 .

[34]  R. Davidson,et al.  Statistical Inference for Stochastic Dominance and for the Measurement of Poverty and Inequality , 1998 .

[35]  Stavros A. Zenios,et al.  Risk factor analysis and portfolio immunization in the corporate bond market , 2005, Eur. J. Oper. Res..

[36]  Frank S. Skinner,et al.  Duration for Bonds with Default Risk , 1997 .

[37]  G. Hübner,et al.  The (more than) 100 Ways to Measure Portfolio Performance. Part 1: Standardized Risk-Adjusted Measures , 2009 .

[38]  Stoyan V. Stoyanov,et al.  Optimal Financial Portfolios , 2005 .

[39]  Frank S. Skinner,et al.  An evaluation of contingent immunization , 2009 .

[40]  F. Redington,et al.  Review of the Principles of Life-office Valuations , 1952 .