Hedging Illiquid Long-Dated Bonds with Shorter-Term Instruments

Summary

The document considers how to hedge a 30-year bond when the most liquid bonds extend only to 10 years. As the bond ages, its maturity eventually enters the liquid part of the curve, where a 10-year bond may provide a closer hedge. The difficult period is the intervening years, when the bond has exposure to maturities beyond the liquid market.

Key ideas

• A long-dated bond may become easier to hedge as its remaining maturity approaches the liquid part of the curve.
• A 10-year bond hedge may not capture the long-end risk of a bond that still has more than 10 years to maturity.
• The response suggests using other assets, including long-dated government securities or swaps, to hedge the less liquid maturity exposure.
• If no suitable hedge is available, the residual risk may be substantial and difficult to manage.

Tags

# duration hedging of illiquid bonds


# duration hedging of illiquid bonds












Let's say that I have a totally illiquid 30Y bond that I want to hedge with short-dated bonds and that the market is liquid up to 10Y bonds.

After 20 years, my 30Y bond will become a 10Y bond so I'll be able to hedge it easily, right?

But how do I hedge it from 30Y to 10Y? In which risk am I exposed to? How can I quantify these risks?

It's an open question, all ideas are welcome, thanks.

## Answer by XYQ (score 3)

https://quant.stackexchange.com/a/39798

After 20 years, your 30 year bond will fall into 10 year bucket. so it has a high correlation with other liquid bond like 10 year and can hedge it easily. Fot the risk exposure between 10 and 30 year, you can hedge it with other type of asset like US, UL, swap. if they are not the available option for you. it hard to manage, you will have a large residual risk to handle.

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