Improving Grid-Based Methods for Estimating Value at Risk of Fixed-IncomePortfolios

摘要

Jamshidian and Zhu (1997) propose a discrete grid method for simplifying thecomputation of Value at Risk (VaR) for xed-income portfolios. Their method relies on two simplications. First, the value of xed income instruments is modeled as depending on a small number of risk factors chosen using principal components analysis. Second, they use a discrete approximation to the distribution of the portfolio's value. We show that their method has two serious shortcomings which imply it cannot accurately estimate VaR for some fixed-income portfolios. First, risk factors chosen using principal components analysis will explain the variation in the yield curve, but they may not explain the variation in the portfolio's value. This will be especially problematic for portfolios that are hedged. Second, their discrete distribution of portfolio value can be a poor approximation to the true continuous distribution. We propose two renements to their method to correct these two shortcomings.