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### Bond Index Replication

Posted: **June 5th, 2020, 1:09 pm**

by **wpatkinson**

Hi All - 1st post to the forums. I am trying to build a bond index replication tool but am struggling to find any useful research papers or method explanations. I am considering using methods such as stratified sampling or PCA. However, having never implemented either method myself in practice i need some help matching them to the problem! Does anyone know of any research papers or code repositories (or any info on the topic) that i could use? Thanks.

### Re: Bond Index Replication

Posted: **June 5th, 2020, 9:52 pm**

by **bearish**

This might have been better posted in the Student forum, but that's not a big deal. What sort of bond index? And what sort of bond data do you have? Before getting excited about techniques for dimension reduction, let's make sure we have lots of excess dimensions to begin with!

### Re: Bond Index Replication

Posted: **June 6th, 2020, 10:50 am**

by **wpatkinson**

Hi bearish, thanks for the reply. the tool i'm trying to make is what a bond index ETF manager would use. firstly i want to be able to create a basket of bonds that replicates the index that the ETF tracks - for example the Invesco US HY Fallen Angels ETF that tracks the FTSE Time-weighted US Fallen Angel Bond index. Then ideally i would like to be able to adjust that small basket with "what if" trades to see how far they push the basket away from the underlying index in risk / tracking error terms. I can pull the required bond data from bloomberg. Hope that helps to clarify a little.

### Re: Bond Index Replication

Posted: **June 6th, 2020, 3:14 pm**

by **Alan**

Ran across

this -- might be of some use.

### Re: Bond Index Replication

Posted: **June 7th, 2020, 10:57 pm**

by **bearish**

OK - so given some universe of bonds, that may be a superset of the index members, you are looking for a set of portfolio weights (many of which presumably zero) so as to minimize some measure of tracking error to the index, subject to some constraints related to liquidity, position size, etc. From a high level, you can go in a couple of very different directions here. The almost model free one would be to try to have your portfolio match the index on things like ratings, OAS, industry and maturity. If a large portfolio is feasible, then this is likely to be pretty robust, but not very precise. The smaller the portfolio, the harder it will be to find the right bonds to match the index. The more quanty approach would be to estimate a set of key rate interest rate durations and some kind of credit quality scaled spread durations, and create a portfolio that closely matches the index on these metrics. Down this path you will encounter, if not dragons, at least plenty of estimation problems. One annoying fact that eliminates many of the statistical techniques relied on by equity people is that you have to be able to deal with new securities on a very regular basis, and the old ones keep on changing their nature (in particular their maturity and OAS).

### Re: Bond Index Replication

Posted: **June 8th, 2020, 7:39 am**

by **wpatkinson**

Hi Alan - thanks. I'll take a proper read through it now. It looks like a good starting point for how the securities are filtered for the benchmark indices.

### Re: Bond Index Replication

Posted: **June 8th, 2020, 7:44 am**

by **wpatkinson**

Hi Bearish - yes that is what i am trying to do. I think i will start by going down the more simple matching route before the estimation route. However, i do think the estimation route will be where i end up.

Not wanting to ask too much - but can you point me in the direction of a relevant text on the subject?