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robertlevine2000
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Posts: 16
Joined: April 14th, 2008, 6:06 pm

hedging a callable bond

November 14th, 2011, 4:26 pm

Hi, is it better practice when hedging a callable bond to hedge based on bond duration, or time to call, rather than actual maturity? Or does the probabilty of call need to be taken into account somehow? Many thanks,
 
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Gmike2000
Posts: 801
Joined: September 25th, 2003, 9:49 pm

hedging a callable bond

November 15th, 2011, 2:51 pm

I am sure you don't need the probability of the call for hedging. Why would you...
 
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robertlevine2000
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Posts: 16
Joined: April 14th, 2008, 6:06 pm

hedging a callable bond

November 15th, 2011, 6:50 pm

Why would that be? In either case, is duration, time to call, or legal maturity the correct basis for hedging?
 
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bearish
Posts: 5425
Joined: February 3rd, 2011, 2:19 pm

hedging a callable bond

November 15th, 2011, 9:28 pm

A first order hedge should be based on option-adjusted duration, which will incorporate the (risk neutral) call probability. I suspect Gmike though it a bit too obvious that you need to somehow account for the call.
 
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robertlevine2000
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Posts: 16
Joined: April 14th, 2008, 6:06 pm

hedging a callable bond

November 16th, 2011, 1:03 pm

Thanks much, and agreed. I guess what I was also asking with probability of call was beyond the first order delta hedge - in other words, hedging the callable with an optional-type structure. How have you seen this done in practice?
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