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Author: | Nawalkha, S.K. Soto, G.M. Zhang, J. |
Title: | Generalized M-vector models for hedging interest rate risk |
Journal: | Journal of Banking and Finance
2003 : AUG, VOL. 27:8, p. 1581-1604 |
Index terms: | Interest rates Risk management Models |
Language: | eng |
Abstract: | This paper generalizes the M-square and M-vector models [by Fong and Fabozzi, Appendix E: Derivation of Risk Immunization Measures, in: Fixed Income Portfolio Management (1985), Dow Jones-Irwin, Homewood, IL, pp. 291294; Nawalkha and Chambers, Journal of Portfolio Management, Winter (1997) 92] by using a Taylor series expansion of the bond return function with respect to specific functions of the cash flow maturities. The classic M-vector computes the weighted averages of the distance between the maturity of each cash flow and the planning horizon, raised to integer powers (e.g., (t-H)1,(t-H)2,(t-H)3,...). Adopting this approach, this paper explores six different generalized M-vector models corresponding to six different polynomial functions, over five different planning horizons from one year to five years. It is shown that generalized M-vector models corresponding to polynomial functions of lower power provide significantly enhanced protection from interest rate risk over short planning horizons. |
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