An Integrated Matching-Immunization Model for Bond Portfolio Optimization

Abstract

We propose an integrated bond portfolio optimization model based on the popular cash-flow matching and immunization strategies. The underlying mathematical program, not only minimizes the initial required capital for the creation of the least cost bond portfolio, satisfying the connected series of liabilities, but also handles the uncertainty of parallel and symmetric shifts on the term structure of short rates. Moreover, a complete investment policy statement regarding the bond portfolio’s structure, the level of diversification, the amount of transaction costs and the lot sizes, is precisely formulated. We verify the validity of the proposed approach through an illustrative empirical testing application, using a well-diversified investment universe of US and European corporate bonds, as well as international sovereign bonds. The qualitative and technical conclusions we report, document the model’s effectiveness and usability.