Using Credit Spread Model to Build Bond Portfolios：A Study of Technology and Material Bond Indices
Date Issued
2016
Date
2016
Author(s)
Liang, Yu-Yi
Abstract
This article shows how to invest the undervalued bonds from different indices. We want to construct the portfolios which is similar to indices, but we can gain higher return and lower risk portfolios. By adopting Merton model to obtain the default probability and other parameters like loss given default(LGD) and systematic risk, we can evaluate the credit spread. When obtaining every credit spreads of bonds, we should measure how much excess credit spread we can get in one unit of loss given default. Meantime, we must use different durations to classify bonds, and then sort bonds by excess credit spreads in every duration. Finally, we invest the top 20% bonds of excess credit spreads to construct portfolios. We use Bloomberg technology and material bond indices as benchmarks. The return and risk of our model portfolios are significantly superior to benchmarks in our back-testing. We find that year-to-year returns of our model portfolios are better and more stable. Also, our model portfolios can reduce the max drawdowns effectively, improve Sharpe ratio, and lower tail risks. Especially, our model has better effect on the material bond index because there are higher risk and lower return in this index.
Subjects
Credit Default Model
Bond Trading Strategy
Merton Option Model
KMV Model
CDS
Back-testing
Type
thesis
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