Risk management in bond markets

: a country-specific study of volatility scaling strategies

Abstract

This study takes a close look at how to deal with the market’s time-variation in risk, with a particular focus on applying volatility-management strategies to bond portfolios, featuring different levels of credit risk and maturities in international fixed-income markets. Notably, the volatility-managed high-yield portfolio, consistently outperforms its original counterpart, both in terms of positive alpha in the spanning regression and significant increase in the Sharpe ratio. However, for high-quality bonds, there is no evidence indicating an enhancement in risk adjusted returns. Mixed evidence is found on the performance of volatility-managed government bond portfolios, with longer maturities portfolios being more likely to profit from the dynamic strategy. When analysing the risk-return trade-off, I show that the reported difference across markets mainly arises from differences in return timing. By applying different volatility estimation methods, I highlight the sensitivity of results to distinct methodologies. In addition to the methodology used, the selected sample and prevailing market dynamics have been shown to have a significant influence on the outcomes. Nevertheless, although evidence seems to suggest some potential benefits, universal improvements in fixed-income markets remain elusive.

Date of Award	25 Jan 2024
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Pedro Barroso (Supervisor)