The Barra U.S. Fixed Income Risk Model.pdfVIP

The Barra U.S. Fixed Income Risk Model Asked to estimate the risk of a portfolio, a manager of fixed income securities might respond by giving the duration of the portfolio, perhaps relative to the duration of a standard benchmark. To estimate both spread risk and exposure to interest rate changes, the manager might also report the durations of various portfolio components (such as the Treasury, agency, corporate, and mortgage components) compared to the corresponding subindices of the benchmark. Duration is a well-understood, single number that identifies the portfolio’s exposure to the level of interest rates, which is the largest source of market risk. Using duration to measure risk, however, leaves several unanswered questions, including the following: ? How do the various sectors interact (for example, how are mortgage spreads affected by a rise in interest rates)? ? How does the risk impact of a one-year-duration overweighting of agency bonds compare to the risk impact of a one-year-duration overweighting of BBB corporates? ? If finer measures of portfolio structure are used (such as sector-by-rating bins), how will the resulting long list of relative durations be used? ? What is the benefit of diversification? For instance, how much is credit risk reduced by using 50 bonds, compared to using just 5, to replicate the corporate index? This paper describes Barra’s approach to answering these kinds of questions in the context of the U.S. fixed income market. The section entitled “Model Structure and Estimation” provides a detailed description of the components, estimation methodology, and quantitative results of the risk model. The section entitled “Model Tests” on page 21 describes test results for the model components. The section entitled “Summary” on page 28 summarizes the results and discusses the future of the model.The Barra U.S. Fixed Income Risk Model 1 Model Structure and Estimation Barra’s U.S. Fixed Income risk model1 (USFI) includes: