The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

CHAPTER 21

Multifactor Fixed Income Risk Models and Their Applications ³⁰¹

Anthony Lazanas, Ph.D. Managing Director Barclays Capital

 

António Baldaque da Silva, Ph.D. Director Barclays Capital

 

Radu Găbudean, Ph.D. Vice President Barclays Capital

 

Arne D. Staal, Ph.D. Vice President Barclays Capital

 

 

 

 

 

Multifactor models were previously discussed (Chapter 5), and their applications to equity portfolios developed in Chapter 13. Although they share a similar framework, multifactor models in fixed income use different building blocks and provide a different analysis into the risk of a portfolio. In this chapter, we discuss risk modeling construction and applications to fixed income portfolios.

When analyzing their holdings, portfolio managers constantly monitor their exposures, typically net of a benchmark: What is the portfolio duration? How risky is the overweight to credit? How does it relate to the exposure to mortgages? What is the exposure to specific issuers? Even when portfolio holdings and exposures are well known, portfolio managers increasingly rely on quantitative techniques to translate this information into a common risk language. Risk models can present a coherent view of the portfolio, its exposures, and how they correlate to each other. They can quantify the risk of each exposure and its contribution to the overall risk of the portfolio.

Fixed income securities are exposed to many different types of risk. Multifactor risk models in this area capture ...