Fixed-income portfolio optimization

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2009-12

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Abstract

The fixed maturity, pricing and cash flow characteristics of fixed-income instruments like bonds distinguish them from equities and complicate the application of mean-variance optimization techniques to bond portfolio management. This report examines the challenges involved and reviews some of the theoretical term structure models and empirical estimation methods that have been proposed to address them. An empirical study is conducted which finds evidence of increased interest rate volatility, which affirms the need for a portfolio approach in fixed-income investing. An optimal portfolio of bond funds constructed using the Markowitz method is found to provide the best risk-return profile over the chosen study period, suggesting the viability of this approach as an alternative to holding bonds.

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