A Study On The Hedging Strategy Of China 's National Debt

China bond market has gained a rapid development in recent years, playing an more and more important role in China’s financial markets. Bond risks are mainly from fluctuations in interest rates. With the growth of interest rate marketization and the increasing scale of the participants, managing interest rate risks and hedging bond portfolios has become an urgent problem. In the background of bond futures as hedging instruments yet to be introduced, this study of the term structure changes and bond portfolio hedging strategy has important oretical and practical significances.Before managing interest rate risks, we have to derive the term structure first. By using the widely applied Nelson-Siegel Svensson model, the paper derives the China’s term structures for bonds in inter-bank bond market from Dec31,2006to Jun25,2009. Results show that the model gives a reasonable estimation of the term structure.Based on the term structure derived above, this paper analyze characteristics and the main impact factors of the yield curve by applying Principal Component Analysis (PCA) method. As the selection of the time horizon has enormous impact on PCA results, we divide the time window into two situations:The period of interest rate stability; The period of interest rate fluctuations. The empirical results show that basically three components namely the level, slope and curvature factor can account for shifts of the term structure. During the period of interest rate stability, the slope and curvature factors play more significant roles respectively while both three factors tend to be stable over time. While during the period of interest rate fluctuations, the level factor perform greater role than previous case while both three factors tend to be unstable over time.At last, this paper compares the traditional duration and convexity hedging and PCA hedging in two cases. We find that PCA hedging may be superior to traditional duration and convexity hedging method in the period of interest rate stability while traditional duration and convexity hedging method has better performance in the period of interest rate fluctuations. By arranging sensitivity of portfolios properly, we can hedge bond portfolios from different risk factors flexibly and effectively.