Optimal Investment in the Fixed-Income Market with Focus on the Term Premium
(English)Manuscript (preprint) (Other academic)
A good estimation of expected returns is imperative when optimal investments are determined with Stochastic Programming model. However, existing Stochastic Programming models do not include a model for the time-varying term premium. In this paper Duffee’s essentially affine model is used to capture the randomness in interest rates and the time-varying term premium. To determine optimal investments, a two-stage Stochastic Programming model without recourse is proposed which models borrowing, shorting and proportional transaction costs. The proposed model is evaluated over the period 1961-2011 and the Sharpe ratio is better than the one’s that corresponds to the market index, and Jensen’s alpha is positive.
Realized premium, Term premium, Forward rates, Stochastic programming
Mathematics Economics and Business
IdentifiersURN: urn:nbn:se:liu:diva-97409OAI: oai:DiVA.org:liu-97409DiVA: diva2:647655