Fixed Income Relative Value Analysis

As western governments issue increasing amounts of debt, the fixed income markets have never been more important. Yet the methods for analyzing these markets have failed to keep pace with recent developments, including the deterioration in the credit quality of many sovereign issuers. This book addresses this gap by illustrating a set of analytic tools for assessing value in the markets for government bonds, interest rate swaps, and related basis swaps, including futures and options.

Taking a practitioner’s viewpoint, and focusing on only the most up to date and relevant models, the book provides a comprehensive approach to Relative Value Analysis by covering the theory, the tools and the implementation of trades. The book covers both statistical models – mean reversion, and principal components analysis (PCA) – and financial models which the successful relative value trader can use to first identify instruments that are both rich and cheap relative to each other, and then apply the financial models in order to gain insights in the reasons for that richness and cheapness. If he sees a sufficient probability for the spread position to be an attractive trade, he can then use statistical models again to calculate, among others, the appropriate hedge ratios and the expected holding horizon. Drawing on the Authors extensive experience the benefits and potential pitfalls of each model are explained fully, as well as practical guidance on the implementation of these models with a number of worked examples. The book is also accompanied by website featuring practical Excel examples of working implementations of the math and associated models contained in the book.