Vega Risk for bonds??

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Vega Risk for bonds??

Postby sruggiero » Tue Mar 15, 2011 10:01 pm

Hi

Does it make sense to have a vega risk limit for a portfolio of ZC bonds?

If it does make sense then would the following also make sense:

We have 1 ZC bond in the portoflio, to find the vega risk we introduce a swaption into the portfolio, find the weight of this swaption to counter any moves in the yield curve(delta-hedging style), so the portfolio is neutral to the yield curve moves , then compute the vega of this swaption with the calculated weight.

Any references welcome.

Cheers

Stevie
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Re: Vega Risk for bonds??

Postby mj » Tue Mar 15, 2011 11:21 pm

vega risk is normally defined as the model change in prices if the implied volatilities of forward rates or swaptions changes whilst the rate remained fixed.

This will be zero for a portfolio of zero coupon bonds.

so you can have a nice tight limit...
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Re: Vega Risk for bonds??

Postby sraks » Wed Mar 16, 2011 2:59 pm

Hi Steevie,

Is this ZC+Swaption portfolio a real construct or hypothetical? Would not a LIBOR floating rate bond be the more natural delta hedge?

I also don't see how a swaption can delta-hedge a ZC. It can protect you if the rate goes up and you enter the swap but swaption is 0 if if rate goes down in which case you gain on the bond. So, you are managing the risk of rate going up but not necessarily delta-hedging.

What am I missing?

Regards,
Sudipta
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Re: Vega Risk for bonds??

Postby sruggiero » Wed Mar 16, 2011 4:50 pm

Thanks MJ for the reply.

Sudipta, the construction is purely hypothetical in order to calculate the "vega" risk of a bond portfolio. I don't think this makes sense...and just wanted to check that.

I have not dreamed this up and it is being used out there...
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Re: Vega Risk for bonds??

Postby sraks » Thu Mar 17, 2011 3:07 am

Stevie,
I suppose a swap can be thought about as a bunch of zero-coupon bonds and we delta-hedge this "bunch" aka a portfolio ( :| )with a suitable swaption. In any case, food for thought.
Thanks,
SR
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