Fixed Income Risk Modeling for Portfolio Managers

Jan 1, 2003

The European credit market, consisting mainly of euro and sterling denominated debt, is second only to the US domestic market in terms of size, influence and liquidity. Not surprisingly, European securities are becoming common in global portfolios. The recent turmoil in credit markets has shown once again that understanding risk is or should be a critical aspect of portfolio management. However, as the European credit market is a mosaic of widely different instruments, issuers, and currencies, identifying and forecasting the risk of European fixed income securities is not a simple task. This chapter will take the reader through the process of building a European risk model and discuss the important sources of risk in generic fixed income portfolios. Our intention is not to cover the whole spectrum of securities but to address some typical modeling challenges such as accommodating different benchmarks and securities, and providing a wide coverage without compromising accuracy. With a general framework in place, the model can be easily extended to cover more markets or bond types