Abstract
In <b><i>A Key Rate Approach to Replicating Annuities with US Treasury Funds</i></b>, from the Summer 2021 issue of <b><i>The Journal of Fixed Income</i></b>, <b>Joseph Prendergast</b> (of the <b>Kogod School of Business at American University</b>) illustrates how retail investors, or their advisors, can replicate an annuity that will save money by avoiding large fees charged by annuity providers. A general approach to achieving this objective is to match the duration of a reference annuity with a replicating portfolio of funds consisting of bonds of various maturities. However, a single duration measure will not adequately capture an asset’s price sensitivity to interest rate changes unless there are only parallel shifts in the yield curve. Prendergast illustrates the use of key rate durations, which correspond to specific points along the yield curve within a constrained optimization, to achieve far more accurate results. Periodic optimization provides replicating portfolio weights for rebalancing so that cash flows closely mimic an annuity.
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