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The Journal of Fixed Income

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From Ad Hoc Bond-Risk Measures to Variance–Covariance Forecasts

Marielle De Jong and Frank J. Fabozzi
The Journal of Fixed Income Spring 2021, 30 (4) 6-16; DOI: https://doi.org/10.3905/jfi.2021.1.105
Marielle De Jong
is an associate professor of finance at the Grenoble Ecole de Management in Grenoble, France
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Frank J. Fabozzi
is a professor of finance at the EDHEC Business School in Nice, France
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Abstract

It is common practice among investors to assess the risks of a fixed-income investment by looking at certain bond characteristics—and at two in particular. The duration provides insight on a bond’s contribution to the interest-rate risk of a portfolio, and the credit spreads provide information about credit risks. Linking these measures together in order to obtain one forecast for the overall price behavior of a bond and bond portfolio is not trivial, however. Although the popular method of taking products, the so-called duration-times-spread rule, is effective and superior to using spread duration, it stops short of delivering complete risk estimates. In this article, the authors propose a method that does provide a complete risk estimate and describe how bond characteristics can be converted into return variance and covariance forecasts.

TOPICS: Fixed income and structured finance, risk management, portfolio construction, statistical methods

Key Findings

  • ▪ This article proposes a method to convert the durations and credit spreads of bond portfolios into return variance and covariance forecasts.

  • ▪ The conversion method is a direct extension of the duration-times-spread rule.

  • ▪ The method helps bridge the gap between front-office portfolio management tools and back-office risk control systems.

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The Journal of Fixed Income: 30 (4)
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From Ad Hoc Bond-Risk Measures to Variance–Covariance Forecasts
Marielle De Jong, Frank J. Fabozzi
The Journal of Fixed Income Mar 2021, 30 (4) 6-16; DOI: 10.3905/jfi.2021.1.105

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From Ad Hoc Bond-Risk Measures to Variance–Covariance Forecasts
Marielle De Jong, Frank J. Fabozzi
The Journal of Fixed Income Mar 2021, 30 (4) 6-16; DOI: 10.3905/jfi.2021.1.105
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