Thursday, February 14, 2008

Increase in bond risk


One way to measure bond risk is to see how returns compare with a simple time series model. Looking at a simple ARIMA model and comparing it with actual Treasury note futures returns shows in more detail how the fixed income world has changed. The last time we say this type of volatility was during the last recession. The residuals may be viewed as surprise risk in bond returns and the surprises are bigger.

A similar pattern of increased residuals also applies to the 5-year and 2-year Treasury note futures. In fact, the variation away from the fitted model is more pronounced.The returns for 2-year Treasuries also more closely follow the monetary cycle.

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