Editor’s Letter

Currently, questions concerning the sources of risk in fixed income markets abound. US government borrowing is now accelerating to levels relative to GDP not seen since 1946 as a result of World War II. Although the US is unlikely to formally default on its debt, the probability of being delinquent on payments is reflected in its credit default swap (CDS) spread. We begin this issue of The Journal of Fixed Income with an article by Ren-Raw Chen, John Finnerty, and Bruno Kamdem that estimates the probability of US payment delinquency over time and how the demand for debt capacity approaching a debt ceiling affects CDS spreads. They also analyze the policy implications of approaching long-term debt capacity. Then, Gary Fissel, Gerald Hanweck, and Anthony Sanders examine the reemergence of low-down-payment (high loan to value) mortgages that were prevalent before the financial crisis and find that they are significantly more likely to become seriously delinquent than traditional 20% or more down payments.

Environmental, social and governance (ESG) factors are the focus of many new investment offerings. In the next article, Lupin Rahman, Jeremy Rosten, Pierre Monroy and Shuo Huang find that there exists an ESG risk premium in emerging market sovereign debt relative to developed markets and that there are no disadvantages of an ESG-focused strategy. Next, Joseph Prendergast extends his prior duration-based methodology for replicating structured annuities by introducing key-rate durations to hedge the risk of slope and curvature changes over the life of the annuity.

In the next article, Robert Goldberg, Ehud Ronn, and Liying Xu provide an alternative methodology for the valuation of callable/putable bonds by allowing volatility to be a function of economically relevant independent variables. Not requiring swaption vols or specifying option-adjusted spreads is an alternative view for determining security selection. Finally, Adama Sanou, Issouf Soumaré, and Claude Fluet apply a dynamic stochastic optimization model with frictions (i.e., a liquidity premium) to solve for the government’s decision to issue a catastrophe bond instead of a standard non-contingent bond.

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

TOPICS: Fixed income and structured finance, fixed-income portfolio management, portfolio theory

Stanley J. Kon

Editor

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