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Estimating Illiquid Bond Risk with Matrix Pricing

Article Quant Q&A · Author: Daniel
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Summary

When corporate bonds trade too infrequently to provide a usable price history, direct historical volatility estimates are unavailable. The suggested workaround is to construct a daily price series through matrix pricing, using comparable bonds where possible or assigning a reasoned spread to a benchmark curve when close comparables are scarce.

Combining the benchmark curve’s daily movements with the selected spread produces estimated daily bond prices that can support risk measurement. This is an indirect estimate: its quality depends on the comparables, benchmark, and spread judgment, and the source offers no validation or specific volatility calculation. The approach may be particularly uncertain in a small market with few similar bonds.

Key ideas

  • Matrix pricing can create a proxy price history for bonds that rarely trade.
  • Use comparable bonds to guide the spread when suitable instruments are available.
  • When comparables are scarce, assign a reasoned spread to a benchmark curve.
  • Apply daily benchmark-curve data and the chosen spread to estimate daily prices for risk analysis.
  • The resulting risk measure depends on judgment and may be uncertain when the market is thin.

Tags

Fixed incomeVolatilityRisk management
Full text
# How to measure the volatility of illiquid bond with no historical prices


# How to measure the volatility of illiquid bond with no historical prices












The basket of corporate bonds that I am following barely traded after the issuance. Hence, there is no historical data to estimate the volatility. Can you suggest me a different approach to come up with a risk related measure. The market is really small and there are not many similar bonds.

Thanks.

## Answer by Helin (score 2)

https://quant.stackexchange.com/a/19364

The best solution is to matrix-price these bonds first. For each bond, either find a comparable bond or use your own judgment to determine the appropriate spread to a benchmark curve (e.g., OAS to LIBOR), then use the daily LIBOR curve and the corresponding OAS to obtain the daily prices.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.