Pricing and Constructing International Government Bond Portfolios
100 Pages Posted: 30 Jan 2022 Last revised: 15 Feb 2024
Date Written: February 3, 2024
Abstract
In developed government bond markets, even simple diversification strategies are shown to offer significant benefits due to imperfectly correlated term-structure dynamics. We derive a stochastic discount factor to price this asset class by projecting returns onto the unconditional mean-variance efficient portfolio. The resulting market price of risk varies substantially over time, peaking during crises and periods of inflation rate dispersion. International bond returns exhibit a strong factor structure, but common sources of return variation show little connection to priced risks. Hedging unpriced risks from naive or factor-based strategies enhances Sharpe ratios significantly, even when portfolio weight limits are imposed.
Keywords: international government bond portfolios, bond risk premia, stochastic discount factor.
JEL Classification: G11, G12, G15.
Suggested Citation: Suggested Citation