Hedging Interest Rate Swaps with DV01 Risk Buckets

Summary

The document explains how to hedge an interest rate swap portfolio using the risk buckets in a delta ladder. When each bucket records the market value change from a one basis point shift in a par instrument, the hedge should offset the portfolio’s DV01 in the corresponding maturity bucket. For example, a negative exposure in a five-year bucket calls for a hedge with an equal positive DV01 there.

The hedge ratio is based on the ratio of the portfolio bucket DV01 to the hedging swap’s DV01, with the sign chosen to offset the risk. The response gives an illustrative zero-rate case in which a five-year swap with a stated notional provides the required hedge, then notes that with nonzero rates the corresponding DV01s determine the ratio. This is a simplified single-bucket explanation; practical hedges may retain curve, basis, and instrument-specific risks that a bucket match does not capture.

Key ideas

• A delta ladder can express swap portfolio sensitivity as DV01 by maturity bucket.
• A hedge should contribute DV01 opposite in sign to the portfolio exposure.
• The required hedge ratio depends on the relative DV01s of the portfolio bucket and hedge instrument.
• Matching one bucket does not necessarily eliminate other curve or basis risks.

Tags

# Hedging Interest rate swaps in practice


# Hedging Interest rate swaps in practice












Suppose we have a portfolio of i terest rate swaps that we wish to delta hedge. we build a delta ladder by shocking the instruments used to build the forecasting and discouting curves (Eurodollar futures, par swaps etc...)

Suppose we wish to hedge by using key par swaps identified from the delta ladder. Im confused about the proper hedge ratio to be used. Do we need to calculate the delta of the par swaps or is the hedge ratio simply the value i. the delta ladder for those instruments?

## Answer by SI7 (score 2)

https://quant.stackexchange.com/a/51639

What you are probably looking for is DV01 based hedging. Let's suppose your delta risk strip is defined as the market value impact of +1bp shift in the par instruments. As an example, suppose you have a risk of -5k DV01 in the 5Y bucket.

In order to completely hedge this -5k DV01 risk, your hedge needs to have +5k DV01 risk. Assuming zero interest rates, your hedge would be to pay 5Y IRS with 10MM of notional. In the general case (nonzero flat IR curve) your hedge ratio is defined as the ratio of the corresponding DV01's.

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