Hedging European Government Bond Portfolios during the Recent Sovereign Debt Crisis

01.11.2014

Empirische Kapitalmarktforschung, Risk & Optimization

Journal of International Financial Markets, Institutions and Money, Volume 33, November 2014, Pages 379–399

Keywords

  • Bond portfolio management
  • Fixed income securities
  • Hedge ratio
  • Hedging effectiveness
  • Interest rate futures
  • Sovereign debt crisis

Autoren

Wolff, Dr. Dominik Bessler, Dr. Wolfgang

Abstract

The sovereign debt crisis challenged investors in European government bonds to deal with volatile interest rate spreads. For managing sovereign risk, “Eurex” introduced futures contracts on Italian government bonds reflecting risks of lower rated countries. We analyze hedging strategies for bond portfolios with futures on German and Italian government bonds before and during the sovereign debt crisis and evaluate their out-of-sample hedging effectiveness. Before the crisis, German futures were efficient instruments for hedging government bond portfolios, but during the crisis, a composite hedge combining German and Italian futures was superior. Allocating bonds to high and low sovereign risk-buckets and hedging these buckets individually further enhanced the hedging efficiency.

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