Quantitative Management of Bond Portfolios / Edition 1

by Lev Dynkin, Anthony Gould, Jay Hyman, Vadim Konstantinovsky, Bruce Phelps

Overview

The practice of institutional bond portfolio management has changed markedly since the late 1980s in response to new financial instruments, investment methodologies, and improved analytics. Investors are looking for a more disciplined, quantitative approach to asset management. Here, five top authorities from a leading Wall Street firm provide practical solutions and feasible methodologies based on investor inquiries. While taking a quantitative approach, they avoid complex mathematical derivations, making the book accessible to a wide audience, including portfolio managers, plan sponsors, research analysts, risk managers, academics, students, and anyone interested in bond portfolio management.


The book covers a range of subjects of concern to fixed-income portfolio managers—investment style, benchmark replication and customization, managing credit and mortgage portfolios, managing central bank reserves, risk optimization, and performance attribution. The first part contains empirical studies of security selection versus asset allocation, index replication with derivatives and bonds, optimal portfolio diversification, and long-horizon performance of assets. The second part covers portfolio management tools for risk budgeting, bottom-up risk modeling, performance attribution, innovative measures of risk sensitivities, and hedging risk exposures.


A first-of-its-kind publication from a team of practitioners at the front lines of financial thinking, this book presents a winning combination of mathematical models, intuitive examples, and clear language.

Product Details

ISBN-13:	9780691128313
Publisher:	Princeton University Press
Publication date:	10/29/2006
Series:	Advances in Financial Engineering , #1
Edition description:	New Edition
Pages:	1000
Product dimensions:	6.00(w) x 9.25(h) x (d)

About the Author

The authors are with the Lehman Brothers Quantitative Portfolio Strategies Group. Lev Dynkin is a Managing Director and the Group's founder and Global Head. Anthony Gould, Jay Hyman, and Vadim Konstantinovsky are Senior Vice Presidents. Bruce Phelps is a Managing Director.

Table of Contents

Foreword by Steve Ross ix

Acknowledgments xi

Note on Authorship xiii





Introduction xv




PART I: Empirical Studies of Portfolio Strategies and Benchmark Design




EVALUATING INVESTMENT STYLE 3




1. Value of Security Selection vs. Asset Allocation in Credit Markets 9
2. Value of Skill in Macro Strategies for Global Fixed-Income Investing 52
3. Cost of the No-Leverage Constraint in Duration Timing 109




INDEX REPLICATION 121




4. Replicating the Lehman Brothers U.S. Aggregate Index with Liquid Instruments 133
5. Replicating the Lehman Brothers Global Aggregate Index with Liquid Instruments 163
6. Tradable Proxy Portfolios for the Lehman Brothers MBS Index 188
7. High Yield Index Replication 215
8. CMBS Index Replication 225




BENCHMARK CUSTOMIZATION 235




9. Evaluating Performance of Long-Horizon Portfolios 241
10. Liability-Based Benchmarks: An Example 283
11. Swap Indices 294
12. Benchmarks for Asset-Swapped Portfolios 317
13. Issuer-Capped and Downgrade-Tolerant U.S. Corporate Indices 327




MANAGING CREDIT PORTFOLIOS 353




14. Sufficient Diversification in Credit Portfolios 363
15. Return Performance of Investment-Grade Bonds after Distress 410
16. Optimal Credit Allocation for Buy-and-Hold Investors 430
17. A Quick Look at Index Tails 465
18. Are Credit Markets Globally Integrated? 475




MANAGING MORTGAGE PORTFOLIOS 499




19. Managing against the Lehman Brothers MBS Index: Prices and Returns 503
20. Evaluating Measures of MBS Duration 519
21. MBS Investing over Long Horizons 556




MANAGING CENTRAL BANK RESERVES 579




22. Total Return Management of Central Bank Reserves 583
23. The Prospects of Negative Annual Total Returns in Short-Duration Treasury Benchmarks 621




PART II: Portfolio Management Tools




OPTIMAL RISK BUDGETING WITH SKILL 631




24. Effect of Security Selection Skill on Optimal Sector Allocation 641
25. Risk Budget Allocation to Issuer and Sector Views 655




MULTIFACTOR RISK MODELING AND PERFORMANCE ATTRIBUTION 677




26. The Global Risk Model: A Portfolio Manager's Guide 681
27. The Hybrid Performance Attribution Model 788




PORTFOLIO AND INDEX ANALYTICS 811




28. Insights on Duration and Convexity 817
29. Portfolio Yields and Durations 825
30. Computing Excess Return of Spread Securities 842
31. Currency-Hedged Returns in Fixed-Income Indices 854
32. The Bund-Treasury Trade in Portfolios 862
33. Empirical Duration of Credit Securities 871
34. Duration Times Spread: A New Measure of Spread Risk for Credit Securities 888
35. Hedging Debt with Equity 935

What People are Saying About This

Leech

I've always been a huge fan of the authors' work. This is their best yet and a 'must read' for anyone interested in bond portfolio management. The authors go beyond the numbers, delving into the issues of portfolio design crucial to the practitioner.
— Kenneth S. Leech, Chief Investment Officer, Western Asset Management Company

Ravi Jagannathan

No single currently available book serves the needs of a person who seeks a fuller understanding of the quantitative management of bond portfolios. This book is exactly what I have been looking for. Not only is there a need for it among students, educators, and professionals, but it also has the potential to influence academic thought by exposing academics to some of the best practices on the street.
— Ravi Jagannathan, Kellogg School of Management, Northwestern University

J. Darrell Duffie

This is the most comprehensive treatment of the analysis of fixed-income strategies for professional asset managers. The coverage is broad and authoritative, with a clear focus on risk and performance relative to benchmarks, across a range of markets. Anyone managing bond portfolios should have a copy.
— J. Darrell Duffie, Stanford University

Simon Benninga

This is a very useful addition to the bond literature, produced by the premier bond group on Wall Street. The chapters cover a wide range of issues that will be of interest to academics who teach and research securities markets, and they are well written. Bond traders, fund managers, and other investment banking professionals will want this book.
— Simon Benninga, Tel Aviv University and the Wharton School, author of "Financial Modeling and Principles of Finance with Excel"

Keith Anderson

This Wall Street research team has become the recognized authority in quantitative approaches to managing bond portfolios, having worked with investors over many years and in many market environments. Their book is well organized, informative, and readable. I highly recommend it to anyone interested in investment management, regardless of their quantitative background.
— Keith Anderson, Chief Investment Officer for Fixed Income, BlackRock

Emanuele Ravano

This team combines intuition with strong empirical research. The greatest achievement of this book is the recognition that very often a portfolio's structure matters as much as its strategies. If you are looking for ways to outperform your benchmarks and competitors, this is a great starting point.
— Emanuele Ravano, Co-Head of Portfolio Management, PIMCO Europe

From the Publisher

"This Wall Street research team has become the recognized authority in quantitative approaches to managing bond portfolios, having worked with investors over many years and in many market environments. Their book is well organized, informative, and readable. I highly recommend it to anyone interested in investment management, regardless of their quantitative background."—Keith Anderson, Chief Investment Officer for Fixed Income, BlackRock

"I've always been a huge fan of the authors' work. This is their best yet and a 'must read' for anyone interested in bond portfolio management. The authors go beyond the numbers, delving into the issues of portfolio design crucial to the practitioner."—Kenneth S. Leech, Chief Investment Officer, Western Asset Management Company

"This team combines intuition with strong empirical research. The greatest achievement of this book is the recognition that very often a portfolio's structure matters as much as its strategies. If you are looking for ways to outperform your benchmarks and competitors, this is a great starting point."—Emanuele Ravano, Co-Head of Portfolio Management, PIMCO Europe

"This is the most comprehensive treatment of the analysis of fixed-income strategies for professional asset managers. The coverage is broad and authoritative, with a clear focus on risk and performance relative to benchmarks, across a range of markets. Anyone managing bond portfolios should have a copy."—J. Darrell Duffie, Stanford University

"Written by the leading minds in quantitative fixed-income portfolio management, this book offers an excellent, accessible guide to sources of superior returns and methods for analyzing portfolio risk and performance."—William N. Goetzmann, Yale University

"No single currently available book serves the needs of a person who seeks a fuller understanding of the quantitative management of bond portfolios. This book is exactly what I have been looking for. Not only is there a need for it among students, educators, and professionals, but it also has the potential to influence academic thought by exposing academics to some of the best practices on the street."—Ravi Jagannathan, Kellogg School of Management, Northwestern University

"This is a very useful addition to the bond literature, produced by the premier bond group on Wall Street. The chapters cover a wide range of issues that will be of interest to academics who teach and research securities markets, and they are well written. Bond traders, fund managers, and other investment banking professionals will want this book."—Simon Benninga, Tel Aviv University and the Wharton School, author of Financial Modeling and Principles of Finance with Excel

Goetzmann

Written by the leading minds in quantitative fixed-income portfolio management, this book offers an excellent, accessible guide to sources of superior returns and methods for analyzing portfolio risk and performance.
— William N. Goetzmann, Yale University

Editorial Reviews

"This Wall Street research team has become the recognized authority in quantitative approaches to managing bond portfolios, having worked with investors over many years and in many market environments. Their book is well organized, informative, and readable. I highly recommend it to anyone interested in investment management, regardless of their quantitative background."—Keith Anderson, Chief Investment Officer for Fixed Income, BlackRock


"I've always been a huge fan of the authors' work. This is their best yet and a 'must read' for anyone interested in bond portfolio management. The authors go beyond the numbers, delving into the issues of portfolio design crucial to the practitioner."—Kenneth S. Leech, Chief Investment Officer, Western Asset Management Company


"This team combines intuition with strong empirical research. The greatest achievement of this book is the recognition that very often a portfolio's structure matters as much as its strategies. If you are looking for ways to outperform your benchmarks and competitors, this is a great starting point."—Emanuele Ravano, Co-Head of Portfolio Management, PIMCO Europe


"This is the most comprehensive treatment of the analysis of fixed-income strategies for professional asset managers. The coverage is broad and authoritative, with a clear focus on risk and performance relative to benchmarks, across a range of markets. Anyone managing bond portfolios should have a copy."—J. Darrell Duffie, Stanford University


"Written by the leading minds in quantitative fixed-income portfolio management, this book offers an excellent, accessible guide to sources of superior returns and methods for analyzing portfolio risk and performance."—William N. Goetzmann, Yale University


"No single currently available book serves the needs of a person who seeks a fuller understanding of the quantitative management of bond portfolios. This book is exactly what I have been looking for. Not only is there a need for it among students, educators, and professionals, but it also has the potential to influence academic thought by exposing academics to some of the best practices on the street."—Ravi Jagannathan, Kellogg School of Management, Northwestern University


"This is a very useful addition to the bond literature, produced by the premier bond group on Wall Street. The chapters cover a wide range of issues that will be of interest to academics who teach and research securities markets, and they are well written. Bond traders, fund managers, and other investment banking professionals will want this book."—Simon Benninga, Tel Aviv University and the Wharton School, author of Financial Modeling and Principles of Finance with Excel

From the Publisher