Editor’s Letter

The performance of security selection within the Agency mortgage-backed securities market is primarily dependent on the quality of the trader’s prepayment model. Each prepayment wave has unique characteristics and an opportunity for dynamic adaptation. We begin this issue of The Journal of Fixed Income with an article by Glenn M. Schultz and Frank J. Fabozzi that applies machine learning technology to prepayment modeling. Their proposed gradient boosted classifier employs loan level learning to the pool level for updating functional form parameters for predicting conditional prepayments.

Given the recent substantial increase in observable inflation, bond portfolio managers are paying significant attention to the direction, level and volatility of future interest rates for value-added trading strategies. In the next article, Lionel Martellini, Riccardo Rebonato, and Jean-Michel Maeso explore momentum and reversal strategies to identify sources of profitability. They find statistically and economically significant positive Sharpe ratios for their reversal cross-sectional strategy that they attribute to the mean-reverting properties of the yield-curve slope.

In the next article, Rainer Jobst and Daniel Rösch investigate the default risk in Euro zone sovereign debt. Their Bayesian approach indicates that bank capital requirements are dependent on the method of estimating the probability of default. Their analysis reveals the increased risk of capital shortfalls associated with allowing zero capital charges for highly rated investments and the incentives for regulatory arbitrage.

A well-functioning market for trading individual bonds and portfolios of bonds is essential for resource allocation. In the next article, Samara Cohen, Stephen Laipply, Ananth Madhavan, and James Mauro analyze custom redemption baskets during the Covid-19 crisis. They demonstrate that iShares redemption baskets during the crisis were consistent with the characteristics of the fund. Next, Vlad Rashkovich and Andrei Iogansen provide a framework for traders to build liquidity trees for projecting bond trading costs.

Finally, Grzegorz Krzyżanowski, Ernesto Mordecki and Andrés Sosa extend the Black-Derman-Toy interest rate tree model to include the possibility of a jump with a small probability in zero interest rate scenarios. They provide a comparison of option prices and implied volatilities on US Treasury bonds.

We hope you enjoy this issue of The Journal of Fixed Income. Your continued support of the journal is greatly appreciated.

Stanley J. Kon

Editor

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