We can give three simple reasons to support the use of volatility products to hedge tail risk in fixed income portfolios. First, equity volatility and bond prices have a strong conceptual link. If you think of a corporate bond as functionally equivalent to a risk-free asset (like a Treasury bond) plus a short put option on the issuer’s assets, then the additional yield you receive above the Treasury rate (a.k.a., credit spread) can be thought of as compensation for the sale of that put option. When equity market volatility jumps drastically (as it does during a tail-risk event), the implicit liability from the short put position increases in probability. In a nutshell, the value of bonds will fall as market volatility (yes, even equity market volatility) rises. Read more
Posts from the ‘Fixed Income’ Category
The Reserve Bank of Australia must be feeling pressure to provide financial markets with explicit forward guidance on the long-term direction of its interest rate strategy. These days, with central banks all over the world providing markets with forward guidance on rates in an effort to shape market expectations, the RBA is one of the few remaining major central banks to maintain a sense of anticipation at each meeting – rates could just as easily go up as they could go down. Even the European Central Bank has finally backed away from its sacred no “pre-commitment” policy. Check out my previous post on forward guidance here.
Increasingly these days, what was once considered to be “abnormal,” markets are beginning to construe as “normal.” A central bank that doesn’t provide forward guidance is increasingly seen as hawkish (“do they have something to hide?”) and markets tend to react by driving up its bond yields and their respective currency – effectively tightening financial conditions.
Chapter 9 – words that are going to be on a lot of lips for some time to come. Last week, Detroit filed for bankruptcy protection under Chapter 9 of the United States Bankruptcy Code, and the Motor City became the largest municipal bankruptcy in history – definitely a dubious distinction. The financial press has focused most attention on the immediate impact to investors in Detroit’s debt, but in our opinion, there will be effects felt by municipal bond investors more broadly, as well as by Detroit’s citizens and workers.
A good deal of ink was spilled last week about how some municipal bond market participants were “concerned” about how some of the city’s general-obligation bonds (those are municipal bonds backed by the full faith and credit of a municipality) were classified as “unsecured” by the Detroit’s emergency manager. Read more
Oh yeah, I’ll tell you something
I think you’ll understand
When I say that something
I want to hold your hand
- “I Want to Hold Your Hand,” The Beatles
Hand-holding is getting to be very popular with the world’s major central banks. Effectively constrained by zero or near-zero interest rates, central banks have been putting greater emphasis on the effectiveness of their communications. Central bank “speak” – if used wisely – holds the power to ease monetary conditions as much as, if not more than, policy rate changes. Read more
Welcome to the new Fixed Income segment of The Principal Blog! The video below gives a quick look at what to expect.
You may have noticed over the past several weeks that in addition to the great economic insights posts here on the Institutional Investor section of The Principal Blog, there have been some guest contributors. Several investment professionals from Principal Global Fixed Income have been writing posts that delve into their areas of expertise. You’ve seen posts on managing volatility and tail risk from Derek White, the head of risk management. You’ve read about bank loan strategies from Mark Cernicky, product specialist. You’ve learned about yields on Japanese government bonds from our global strategist, Seema Shah. And you’ve read about 10 concrete concepts to researching high yield from Phelps Hoyt, our head of high yield research.
I’m delighted to announce that because of the positive response we’ve received on the fixed income blog posts, we’ll be expanding our Institutional Investor section to include regular posts from the fixed income team! Read more
The 2013 Principal Global Investors/CREATE-Research report is due to be launched on June 17th. Each year, a survey focus is chosen after canvassing the views of thought leaders in the investment value chain worldwide. The research topic selected for 2013 is investing in today’s debt-fuelled world. The resulting research report, Investing in a Debt Fuelled World, takes a look at what it means to be an investor in a world where many major economies are trying to cut their debt mountains mostly via a combination of low interest rates and inflation. Read more