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Bond ladders and optimal portfolios


Judd, Kenneth L; Kübler, Felix; Schmedders, Karl (2009). Bond ladders and optimal portfolios. Swiss Finance Institute Research Paper Series 12, University of Zurich.

Abstract

Many bond portfolio managers argue that bond laddering tends to outperform other bond investment strategies because it reduces both market price risk and reinvestment risk for a bond portfolio in the presence of interest rate uncertainty. Despite the popularity of bond ladders as a
strategy for managing investments in fixed-income securities, there is surprising little reference
to this subject in the economics and finance literature. In this paper we analyze complex bond portfolios within the framework of a dynamic general equilibrium asset-pricing model. Equilibrium bond portfolios are nonsensical, implying a trading volume that vastly exceeds observed
trading volume on ¯nancial markets. Such portfolios would also be very costly and thus suboptimal in the presence of even very small transaction costs. Instead portfolios combining bond ladders with a market portfolio of equity assets are nearly optimal investment strategies, which
in addition would minimize transaction costs. This paper, therefore, provides a rationale for bond ladders as a popular bond investment strategy.

Many bond portfolio managers argue that bond laddering tends to outperform other bond investment strategies because it reduces both market price risk and reinvestment risk for a bond portfolio in the presence of interest rate uncertainty. Despite the popularity of bond ladders as a
strategy for managing investments in fixed-income securities, there is surprising little reference
to this subject in the economics and finance literature. In this paper we analyze complex bond portfolios within the framework of a dynamic general equilibrium asset-pricing model. Equilibrium bond portfolios are nonsensical, implying a trading volume that vastly exceeds observed
trading volume on ¯nancial markets. Such portfolios would also be very costly and thus suboptimal in the presence of even very small transaction costs. Instead portfolios combining bond ladders with a market portfolio of equity assets are nearly optimal investment strategies, which
in addition would minimize transaction costs. This paper, therefore, provides a rationale for bond ladders as a popular bond investment strategy.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:17 December 2009
Deposited On:07 Sep 2011 07:22
Last Modified:05 Apr 2016 14:59
Series Name:Swiss Finance Institute Research Paper Series
Number of Pages:38
Related URLs:http://dx.doi.org/10.2139/ssrn.1289257
Permanent URL: https://doi.org/10.5167/uzh-49288

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