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Hedging High Yield and Emerging Market Bond Tail Risk with VIX® Futures

Berlinda Liu and Hong Xie
The Journal of Alternative Investments Fall 2019, jai.2019.1.080; DOI: https://doi.org/10.3905/jai.2019.1.080
Berlinda Liu
is a Director of Research & Design at S&P Dow Jones Indices, New York, NY
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Hong Xie
is a Senior Director of Research & Designat at S&P Dow Jones Indices, New York, NY
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Abstract

In this article, the authors suggest a different approach to hedging tail risk in certain segments of the fixed income market. VIX® futures are based on the implied volatility of equities and therefore are not an obvious choice for hedging the tail risk of bonds. Nevertheless, the authors show that there is a negative correlation between returns for credit-focused bonds and VIX futures, and the strength of the inverse relationship increases during down markets, precisely when the hedge is most needed. This should not be too surprising given that credit risk is positively correlated with equity market risk. In this light, VIX futures, tradable instruments linked to the VIX, become a viable alternative hedging instrument for bonds with significant credit risk. Because there are significant roll costs associated with VIX futures during non-stressed periods, a static hedge will create a drag on returns, but a dynamic hedge can effectively reduce credit-focused bond losses during times of stress.

TOPICS: Emerging markets, tail risks, futures and forward contracts

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The Journal of Alternative Investments: 23 (3)
The Journal of Alternative Investments
Vol. 23, Issue 3
Winter 2021
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Hedging High Yield and Emerging Market Bond Tail Risk with VIX® Futures
Berlinda Liu, Hong Xie
The Journal of Alternative Investments Aug 2019, jai.2019.1.080; DOI: 10.3905/jai.2019.1.080

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Hedging High Yield and Emerging Market Bond Tail Risk with VIX® Futures
Berlinda Liu, Hong Xie
The Journal of Alternative Investments Aug 2019, jai.2019.1.080; DOI: 10.3905/jai.2019.1.080
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  • Article
    • Abstract
    • THE CHALLENGE OF HEDGING TAIL RISK OF CREDIT PORTFOLIOS
    • VIX AND VIX FUTURES
    • DATA
    • CORRELATION AND BETA ANALYSIS
    • VIX FUTURES TERM STRUCTURE IN DOWN MARKETS
    • HEDGING CREDIT BOND PORTFOLIOS WITH VIX FUTURES
    • HEDGING A HIGH YIELD BOND PORTFOLIO
    • CONCLUSIONS
    • ADDITIONAL READING
    • REFERENCES
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  • PDF (Subscribers Only)

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