Tail Risk in Fixed-Income Markets

97 Pages Posted: 18 Nov 2013 Last revised: 23 Jan 2016

See all articles by Haitao Li

Haitao Li

University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business; Cheung Kong Graduate School of Business

Zhaogang Song

Johns Hopkins University - Carey Business School

Date Written: April 16, 2015

Abstract

The importance of tail risk for asset pricing has been widely recognized in the literature and extensively studied for equity markets empirically. We construct one of the first model-free measures of tail risk for fixed-income markets using a proprietary dataset of swaptions, denoted as TAIL, which captures tail risk at different horizons and in recessional states with high or low interest rates. We show that TAIL has strong predictive power for returns on Treasury bonds, corporate bonds, mortgage-backed securities, fixed-income hedge funds, and even equities, suggesting that interest rate tail risk is universally priced in all major financial markets. We also find strong links between TAIL and economic fundamentals.

Keywords: Fixed-income, Swaption, Tail risk

JEL Classification: G12, G13

Suggested Citation

Li, Haitao and Song, Zhaogang, Tail Risk in Fixed-Income Markets (April 16, 2015). Available at SSRN: https://ssrn.com/abstract=2355931 or http://dx.doi.org/10.2139/ssrn.2355931

Haitao Li

University of Michigan - Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-615-5475 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Zhaogang Song (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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