Modeling Active Management in the Japanese Bond Market

Abstract

The authors use a simulation methodology to assess the potential value added and residual risk from active management in the Japanese bond market. They examine the performance potential of taking bets on both credit sectors and interest rates, as well as combination strategies. They compare the results from taking bets of different sizes and skill levels to the returns of actual managers and to simulated U.S. strategies over the same period. Illiquidity in Japanese spread sectors severely limits the opportunity for managers to add value using credit strategies instead of the established broad market benchmark, even at high skill levels.