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|Title: ||Hedging the Interest Rate Risk of Brady Bonds|
|Authors: ||Jacob, Boudoukh|
Whitelaw, Robert F.
|Issue Date: ||3-Jul-1996 |
|Series/Report no.: ||FIN-96-016|
|Abstract: ||While there is significant interest in investing in Brady bonds, the
source of attraction is often the exposure to sovereign risk (and its
yield compensation), while the exposure to U.S. interest rate risk is a
“necessary evil”. This paper addresses the problem of
determining the interest rate sensitivity of Brady debt. WE show that
the most relevant state variables in determining the duration of a Brady
bond are U.S. interest rates and the bond’s strip spread.
Motivated by the difficult of using structural models to price and hedge
Brady debt, we provide a model-free approach to estimating the hedge
ratio. Using our approach to hedge the Argentinian Par and Discount
Brady bonds, we find that only a small fraction (15% or so) of the total
risk is hedgeable, but our hedged portfolio exhibits little covariation
with U.S. interest rates.|
|Appears in Collections:||Finance Working Papers|
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