Hedging and Replication of Fixed-Income Portfolios

Abstract

This article discusses hedging and replication strategies based on Eurodollar futures, Treasury futures, and swaps for diversified fixed-income portfolios. Analytical and empirical hedge ratio approaches are empirically tested on a variety of fixed-income indexes. Tracking errors are found to have significantly increased since the middle of 1998. The optimal replication portfolios are generally found to be hybrid portfolios consisting of a combination of Treasury futures and Eurodollar futures and swaps at a long-term cost of between 4 and 12 basis points.