Work in progress
In my dissertation "Robust Bond Investment Strategies under Parameter Uncertainty", you find three chapters. I include the corresponding titles and abstracts below.Â
1. Robust Hedging of Terminal Wealth under Interest Rate Risk and Inflation Risk - with Anne Balter and Frank de Jong.
Long-term investors face challenges in hedging both interest rate and inflation risks. We assume that these risks follow a bivariate mean-reverting process, and we demonstrate that optimal allocations to nominal bonds are sensitive to small changes in the parameters of the risk factors process. The investor may face significant potential losses in utility due to estimation errors in the mean-reversion parameters and the feedback parameter, which accounts for the impact of the level of the inflation rate on the drift of the nominal interest rate. We show that single-bond strategies can lead to smaller utility losses in case of estimation errors than the initially optimal two-bond strategy.
2. Robust Hedging of Terminal Wealth under Interest Rate Risk with the Constraint Approach - with Anne Balter and Frank de Jong.
Long-term investors hedge their liabilities against interest rate risk by nominal bond investments. However, model-based optimal bond allocations are very sensitive to the underlying parameters, so that an investor who ignores parameter uncertainty may face a large utility loss. Therefore, we consider a robust bond investor who takes into account parameter uncertainty. We apply the constraint approach that limits the considered entropy around the market price of risk and the mean-reversion parameter. In case of only uncertainty about the market prices of risk, we find that the strategy of a speculative investor shrinks to that of a hedge investor. If we additionally allow uncertainty about the mean-reversion parameter, we find state- and horizon-dependent robust bond allocations.
3. Bond Allocations under Climate Risk and Parameter Uncertainty - single authored
Climate change is expected to affect long-term bond returns, though quantifying this impact remains difficult. We therefore analyse the implications of parameter uncertainty related to the impact of climate risk on the optimal bond allocations of a long-term investor, based on an affine term structure model. If the investor is uncertain whether climate risk impact bond returns, we find that a robust strategy is to invest based on the assumption that there is a climate impact. If a speculative investor correctly assumes a climate effect but is uncertain about the underlying parameters, she should be concerned about an estimation error in the correlation between shocks in the climate risk factor and interest rates. We propose a robust strategy that can mitigate potential utility losses arising from these estimation errors.