Monthly Rebalancing for Rule-Based Bond Indices
Summary
The document describes how to maintain a bond price or return index when eligible bonds mature, lose qualification, or are newly issued. It recommends a rule-based process that selects the eligible basket at each month end using stated criteria such as country, credit rating, maturity, and minimum par amount. That basket becomes the returns universe used to calculate daily returns in the following month.
Changes in eligibility during the month are recorded in a statistical universe, which informs the next rebalance but does not alter the basket used for current-month returns. At month end, the statistical universe replaces the prior returns universe and the cycle repeats. The approach is presented as common bond-index practice, alongside a reference to a Laspeyres-type index, but the document does not detail the weighting formula, treatment of prices or accrued interest, or how index continuity is calculated. Those specifications would need to be set separately for a particular index.
Key ideas
- A rule-based bond index selects eligible constituents at a scheduled monthly rebalance.
- The selected returns universe stays fixed for daily return calculations during the following month.
- In-month eligibility changes are tracked in a statistical universe for the next rebalance.
- At month end, the statistical universe becomes the new returns universe.
- The document points to a Laspeyres-type approach but does not specify its full calculation.
Tags
Full text
# Custom Bond Index Construction # Custom Bond Index Construction Let's say there are about 100 illiquid EM bonds. I would like to construct a Price Index of these bonds to see the overall performance of these instruments. I have their issue volume `(number of bonds x face value)` that will be used to find each bond's weight. However, after some time some of the bonds will mature or will be excluded if their rating falls. Also, there will be some new issues which will qualify for inclusion to the Index. Can anybody tell how can I effectively account for such events? As per my findings there are two basic types of Price Index construction approaches - Paasche and Laspeyres. But thus far I have not encountered them in some of the bond index construction methodologies. ## Answer by Helin (score 6, accepted) https://quant.stackexchange.com/a/34141 As @noob2 pointed out, a Laspeyeres type index is the way to go, so I'll focus on other parts of your question. Nearly all bond indices are rule-based and rebalanced monthly. At the end of each month, based on a pre-determined set of rules (countries, credit rating range, maturity range, minimum par amount, etc.), you select a basket of bonds. This basket is known as the "returns universe" and is used to compute the daily returns for the next month. As the month progresses, some of the bonds may be disqualified (perhaps due to a credit event or maturity being too short) and other bonds may qualify. These subtractions and additions result in a forward-looking "statistical universe," but have no impact on the current "returns universe." In other words, these events do not change the bonds you use to calculate returns for the current month. At the end of the month, the statistical universe replaces the old returns universe as the new returns universe, and the cycle starts again.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.