DAY 1: Statistical Relative Value Models
Introduction to Fixed Income Relative Value (RV) Analysis
- Concept of RV analysis
- Sources of RV opportunities
- The insights from RV analysis
- Applications of RV analysis: Trading, hedging, asset selection, creating alpha
- RV models: Statistical and financial models and their interaction
Principal Component Analysis (PCA): Theory
- What is PCA and how does it help us?
- PCA versus other factor models
- Mathematics of PCA
- Gaining insights into market mechanisms through interpretation of the PCA results
- Decomposing a market into directional (beta) and non-directional (alpha) factors
- Using PCA to screen the market for trading opportunities
- Using PCA for asset selection
- Combining all these elements into a step-by-step guide for PCA-based analysis and trading
Principal Component Analysis: Practice
- Using PCA for yield curve analysis
- Using PCA for swaption analysis
- Using PCA for hedging and asset selection
- Using PCA in other markets: Stocks, FX, commodities
Mean Reversion: Theory
- What is mean reversion and how does it help us?
- Mathematics and model selection
- Calculating conditional expectations and probability densities
- Calculating Sharpe ratios
- Calculating first passage times
Mean Reversion: Practice
- Which performance is likely over which horizon?
- Setting performance targets
- Setting stop loss levels
Practical Case Study: Applying Statistical RV Models in a Trading Context
- Perform a PCA on the yield curve and find trading opportunities
- Run a mean reversion model to assess the performance potential and speed of these trades
Day 2: Asset swaps, basis swaps, default swaps, and their combinations
Asset swap spreads (ASW)
- Model approach: Link between ASW and LIBOR-repo spreads
- A model for pricing ASW
- Driving factors of ASW
- Making the pricing model for ASW work in practice
- ASW as rich/cheap indicator for bonds: Problems and better alternatives
Basis swaps (BSW)
- Intra-currency basis swaps
- Cross-currency basis swaps
- Swapping bonds into a different currency
- Assessing the relative value between bonds in different currencies
- The mutual influences between ASW and BSW
Credit Default Swaps (CDS) for Government Bonds
- FX component and other pricing issues
- The “arbitrage inequality” between ASW, BSW and CDS
- Trading this “arbitrage inequality” in practice
Practical Case Studies
- Practical case study 1: The mutual influences of ASW, BSW and CDS in the JGB market
- Practical case study 2: Building a model for EMU sovereign bond yields
Day 3: Futures and Options
Bond futures and their delivery option
- The importance of the delivery option
- Usual approach to price the delivery option and its problems
- A better approach to price the delivery option
- Applications: Basis trades and calendar spreads/rolls
Swaption trading strategies
- Brief review of option pricing theory
- Classification of option trades
- Different exposures and goals of the different option trades
Swaption trading strategy 1: Conditional curve trades
- Single underlying: Breakeven analysis, breakeven curves, link to macro models
- Multiple underlyings: Conditional steepeners and butterflies
Swaption trading strategy 2: Implied versus realized volatility
- Single underlying: Delta hedging, calculation of realized volatility
- Multiple underlyings: Implied vol curve versus realized vol curve
Swaption trading strategy 3: Implied versus implied volatility
- Factor model for the swaption vol surface
- Practical pitfalls
Practical case study: Finding, classifying and analysing swaption trades on the USD vol surface