Bond Risk Pricing,Decomposition And Control

Risk is one of the essential features of financial markets, and risk management is one of the important part of investment management. Bond markets is a major component of financial markets, therefore the bond market’s methodology of risk management and its risk control ability is also an important manifestation of the development level of a country’s financial markets.The effectiveness of financial markets depend in large part on their own risk management capability, and the capability of risk management depends on the appropriateness of risk management methods.The development of China’s bond market is not too long. As an important part of the interest rate marketization reform, the interbank bond market originated in1997, and its rapid development began around2005. Its early development focused on "quantity" expansion, and mainly uses "the doctrine of attitude on risk management. As "the doctrine of out of time, supervisors are more inclined to involvement of the Executive Force. Today, the capacity of domestic bond market has become the second large of the world. Due to the lack of a suitable methodology of risk management, it still can not refer to as an efficient market.At present, China’s interest rate marketization reform has reach its final crucial stage. Can we build a risk management methodologies in domestic bond market that suits China’s actual situation or not, it is not only essential to the development of bond market itself, but also to the interest rate marketization reform on the whole.This is the writing background and purpose of this dissertation.The purpose of this dissertation is to build a relatively systematic risk management methodology of bond market.lt including three aspects,that is risk pricing, risk decomposition, and risk control.At present, the risk control of financial markets, mainly through diversification of portfolio(The derivatives used to hedge risk can also be seen as an asset in the portfolio). Therefore, we divided bond risk into two parts of systemic risk(non-diversifiable) and non-systemic risk(diversifiable) first, according to the standard of diversification.Risk premium is used to measure systemic risk,and VaR(Value at Risk) is used to measure non-systemic risk.Risk decomposition is the central aspect of this research.This research synthesize two ways of principal components analysis(PCA) and construction of risk factors,and chosen interest rate risk(major part of market risk in domestic market),credit risk and liquidity risk as research objects. First, we determine the levels of risks through principal component analysis. Then, construct the overall risk factors of different risks, using risk factor construction method. Finally, compound risk factors and the order of principal components,we constructed a wo dimensions risk factor system of risk factors and term structures. Then achieve the purpose of risk decomposition.The risk pricing depends on the market as a whole, but risk control focus on bond’s specific(non-systematic) risk.This dissertation makes full use of the relationship between systematic risk and non systematic risk. First, we decomposed systematic risk(Risk premium). It formed a "prices" of the risk factor system,and we looked them as the pricing of the whole market for risk factors.Then we took the regression on non-systematic risk(VaR) to the "prices" of the risk factor system, and obtained influencing factors of each risk factor for VaR. That is the decomposition of non-systematic risk.In the risk-controlling studies,we improve the method of "risk mapping"."Risk mapping" method maps risks to a certain set of "basic building blocks" which are mostly representative indices and assets. We directly mapped risks to the more fundamental "risk factor system" which decomposed from the risk of market itself. From the idea of principal component analysis, risk factors based on the same risk are essentially orthogonal. It makes things much easier for risk control. In addition, the concept of "market" here is relative, the range of "market" determined by the impact on portfolio specifically in practice.Risk factors are time-varying, especially in times of crisis,it takes challenges for portfolio adjustment. But for the same bond, the affect order of different risk factors is relatively stable.Unlike mainstream of analyzing the correlation between assets among portfolio(or between assets and portfolio),this dissertation studied correlations between a specific asset and the overall market. And we take more emphasis on the relative size of risk factors’ impact(the order). Portfolios constructed by this method are more stable, need fewer adjustments. It fits more for emerging markets which lack of liquidity, including China’s bond market.Finally, we verify the feasibility of the above methodology through two methods, simulation and empirical test.Bond risk pricing, decomposition and control is an organic system in logical structure. They are relatively isolated in research structure, and form their own system.On the risk pricing study, we used historical simulation results as a basis for further research.We also studied the method of stochastic simulation and make comparison with historical simulation. On the risk decomposition study, we not only proposed a method of constructing risk factor system, but also clearly show the dominant risk factor and its variations through the time series paths of risk factor. Based on risk factor system, we presents concepts of "average market premium" and "relative premium", they are useful for bond selection in investment practice. On the risk control study, we propose a risk control method based on risk factors, and made a comparison with the method based on incremental VaR(IVaR). In addition, we presented three major exposures aspects in bond investment, from the perspective of the overall bond risk controlling. They are holding risk(which has been studied in this dissertation), trading risk(mainly liquidity risk),and risks in extreme events. The latter two are not the focus of this dissertation. As an integral part of risk control in practice of bond investment, we also made some discussion or presentation in the dissertation.