Bond Portfolio Optimization in the Presence of Duration Constraints

Written on 19 Jul 2018.

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EDHEC-Risk Institute research article in the Journal of Fixed Income

We are pleased to enclose an EDHEC-Risk Institute research article published in the Summer 2018 issue of the Journal of Fixed Income entitled "Bond Portfolio Optimization in the Presence of Duration Constraints". In this article, authors Romain Deguest, Frank J. Fabozzi, Lionel Martellini and Vincent Milhau discuss the implementation and the benefits of portfolio optimization techniques by testing them in a universe made of real-world coupon-paying bonds.

Although there exists an abundant literature on the benefits and limits of scientific diversification in the equity universe, little is known about the out-of-sample performance of portfolio optimization models in the fixed-income universe. In this article, the authors address two key challenges that are specific to bond portfolio optimization, namely, the presence of duration constraints and the presence of no-arbitrage restrictions on risk parameter estimates, for which no equivalent exists in the equity universe.

In an application to sovereign bonds in the eurozone, they find that the use of portfolio optimization techniques based on robust estimators for risk parameters generates an improvement in investor welfare compared with the use of ad hoc bond benchmarks such as equally weighted or cap-weighted portfolios. These results are robust with respect to changes in the number of constituents in the portfolio and the rebalancing period, and in the presence of duration or weight constraints.