Fixed Income Risk -Statistical

Overview

The statistical approach to fixed income risk models the value of fixed income securities (and therefore portfolios) as random variables. That is, they can take any of a number of possible values at a future date, with probabilities associated with each value. The challenge becomes determining how to assign a distribution to the various random variables being modeled.

Topics

• Term structure models are used as a basis for many fixed income statistical models. They model the term structure of the yield curve statistically first, and then derive the distribution of individual assets from the distribution of the yield curve.
• Hedging refers to the process of trading instruments in a portfolio in order to make the portfolio immune to fluctuations in the interest rate curve.
• The bond pricing equation is a differential equation (similar to the black scholes equation) which specifies the evolution of a bond price when one has a model for the short rate.