Abstract
Pension funds and life insurers face interest rate risk arising from the duration mismatch of their assets and liabilities. With the aim of hedging long-term liabilities, we estimate variations of a Nelson-Siegel model using swap returns with maturities up to 50 years. We consider versions with three and five factors, as well as constant and time-varying factor loadings. We find that we need either five factors or time-varying factor loadings in the three-factor model to accommodate the long end of the yield curve. The resulting factor hedge portfolios perform poorly due to strong multicollinearity of the factor loadings in the long end, and are easily beaten by a robust, near Mean-Squared-Error- optimal, hedging strategy that concentrates its weight on the longest available liquid bond.
| Original language | English |
|---|---|
| Pages (from-to) | 505-538 |
| Number of pages | 34 |
| Journal | Journal of Financial Econometrics |
| Volume | 20 |
| Issue number | 3 |
| Early online date | 23 Oct 2020 |
| DOIs | |
| Publication status | Published - 2022 |
Bibliographical note
JEL classification: G12, C32, C53, C58Funding Information:
Part of this research was financially supported by a grant from the Global Risk Institute.
Publisher Copyright: © 2020 The Author(s) 2020. Published by Oxford University Press.
Funding Information:
Part of this research was financially supported by a grant from the Global Risk Institute.
Publisher Copyright:
© 2020 The Author(s) 2020. Published by Oxford University Press.