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The use of derivatives by sovereigns: An analysis of pre-hedging interest rate risk ahead of auctions
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Orientador(es)
Resumo(s)
This study investigates whether interest rate swaps and German bond futures can effectively
protect sovereign issuers from rising interest rates surrounding bond auction dates. The
research aims to determine if using these instruments can successfully lock in the risk-free
rate and shield debt management agencies from interest rate hikes leading up to auctions.
The analysis employs data on benchmark bond yields from four EMU countries – Portugal,
Spain, Italy, and Germany – and corresponding swap rates for various maturities, covering the
period from March 2000 to December 2019. The data is categorized into bull and bear markets
to refine the hedging strategies. The study excludes the period marked by the 2008 financial
crisis (March 9, 2009, to August 8, 2017) due to its high volatility and focuses instead on the
post-crisis period, characterized by negative interest rates. The analysis reveals that interest
rate swaps provide better results than German bund futures in locking in the risk-free rate.
However, both strategies show similar limitations in fully mitigating interest rate risk. While
they can effectively hedge against fluctuations in the risk-free rate component of the yield
curve, they leave the risk premium component, also known as the z-spread, unhedged.
Consequently, both strategies' success is contingent upon the magnitude of changes in the
countries' yields compared to the changes in benchmark rates. A key factor impacting the risk
premium is the sensitivity of credit spreads to auction announcements, especially for Portugal
and Spain. A phenomenon exacerbated by the unpredictability of auction timing and
frequency, leading to increased volatility in the days leading up to auctions. Future research
could explore alternative financial instruments and strategies for pre-hedging interest rate
increases around auction dates. Furthermore, investigations into the liquidity, regulatory, and
operational implications of employing these derivatives would provide valuable insights for
debt management agencies.
Descrição
Dissertation presented as the partial requirement for obtaining a Master's degree in Statistics and Information Management, specialization in Risk Analysis and Management
Palavras-chave
Sovereign debt Futures Swaps Interest Rate Bonds Interest Rate Risk SDG 4 - Quality education SDG 8 - Decent work and economic growth