Derivatives Strategies for Bond Portfolios

Felix Goltz
Research Engineer at EDHEC Risk and Asset Management Research Centre

Abstract

In this paper, we examine how standard exchange traded fixed income derivatives (futures and options on futures contracts) can be included in a sound risk and asset management process so as to improve risk and return performance characteristics ofmanaged portfolios.

Our results show that the non-linear character of the returns on protective option strategies offers appealing risk reduction properties in the pure asset management context. Consequently, such strategies should optimally receive a significant allocation, especially when investors are concerned with minimising extreme risks.

In an asset liability management context, we also show that fixed income derivatives in general, and recently launched long-term futures contracts in particular, offer significant shortfall risk reduction benefits. These results have potentially significant implications in the context of
an increased focus on matching liability portfolios.