Research Of Interest Rate Derivative Hedging

The volume of trade in the interest rate derivative market increases rapidly and has accounted for more than 70 percent of the OTC financial derivative trading. The development status of the financial derivative market in our country falls far behind that in developed countries. By gradual reform of the interest rate marketization and the perfection of the government bond market, the conditions for developing the interest rate derivative in our country have become sufficient. Financial institutions demand strongly the interest rate risk management tools and our country now has the ability to propose the interest rate derivatives.In the dissertation the hedging theory is analyzed, the common duration-based hedging strategy is commented on and thus the conception of convexity bias is introduced. By constructing a hedged portfolio of an interest rate forward contract and a short-term interest rate futures contract, the hedging strategy based on the convexity bias adjustment is derived and improved. It is proposed that the changes in the portfolio value consist of four parts, which are changes in the futures rate, changes in the unit discount bond price, co-movements between the futures rate and the bond price and changes in the covariance term. By further derivation, it is proposed that the convexity bias is composed of the covariance term effect, the maturity effect and the yield curve effect, while the traditional convexity bias model only contains the convexity bias. The modified model is applied to the convexity bias adjustment of the hedged portfolio of the interest rate forward contract and the short-term interest rate futures contract and the perfect hedge ratio is obtained. Once the convexity bias adjustment is completed, the hedged portfolio generates zero excess return.Since the theoretic model is made under the risk-free market assumption while the positive data come from Eurodollar market, it is necessary to modify the process of the forward LIBOR interest rate in the Eurodollar market to make the model suitable for the risky Eurodollar market. This dissertation modifies the LIBOR volatility function by expressing the deterministic function in the BGM model in the way of exponential decay and thus makes the volatility function bears the proportional and exponential forms at the same time. The exponential form demonstrates the mean-reversion property of the long-term rates, while the proportional form incorporates the level of interest rates.With positive data the sensitivity of the convexity bias in the Eurodollar market is analyzed and the volatility effect, the maturity effect and the yield curve effect of the convexity bias adjustment are estimated. The concluding is: The longer the maturity, the greater is the CBA given the volatility and the yield curve; The higher the volatility, the greater is the CBA given the term and the yield curve. Other things being equal, the more upward-sloping the slope of the yield curve, the greater the CBA; the higher the swap value, the greater the CBA; the higher the interest rate, the greater is the CBA. The maturity effects, the volatility effects and the yield curve effects estimated with the BH model, HW model and the modified CBA model are compared and corresponding conclusions are drawn: The BH model underestimates the CBA, so it overestimates the swap value; The HW model overestimates the CBA, so it underestimates the swap value; The swap value estimated from modified BGM-based model is less than bid-offer spreads to avoid riskless profitable opportunities from two-year term to ten-year term.