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Interest Rate Future Quality Options and Negative Interest Rates

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URI: https://hdl.handle.net/10016/24859
ISSN: 1989-8843
UXXI: DT/0000001575
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indemwp17_03.pdf (542.86 KB)
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2017-07-10
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Abstract
This paper verifies the existence of diversification gains from considering the "quality option asset strategy", which adds the portfolio replicating the interest rate future quality option, as proposed by Balbás and Reichardt (2010), and a portfolio comprised of stock and bonds. The empirical results show that the gains are statistically and economically significant, especially in the negative one-month Euribor rate period. The out-of-sample optimal tangency portfolio, which includes "quality option replicas", delivers an increase in the Sharpe ratio of around 40%, as well as a positive returnHloss oIseJng the costs of higher turnover. The main source of the diversiKcaLon gains emanates from the very low correlation between quality options and stocks. Furthermore, the (at least theoretical) existence of sequential arbitrage under negative rates magnifies the low correlation effect.
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Interest rate future quality option, Asset Allocation, Mean-variance frontier, Negative interest rates
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INDEM - Working Paper Business Economic Series