ARIK BEN DOR, PHD, is a Director and Senior Analyst in the Quantitative Portfolio Strategy (QPS) Group at Barclays Capital Research. He joined the group in 2004 after completing a PhD in finance from the Kellogg School of Management. Ben Dor has published extensively in the Journal of Portfolio Management, Journal of Fixed Income, and Journal of Alternative Investments. LEV DYNKIN, PHD, is the founder and Global Head of the Quantitative Portfolio Strategy Group at Barclays Capital Research. Dynkin and the QPS group joined Barclays Capital in 2008 from Lehman Brothers where the group was a part of fixed income research since 1987—one of the longest tenures for an investor-focused research group on Wall Street. JAY HYMAN, PHD, is a Managing Director in the Quantitative Portfolio Strategy Group at Barclays Capital Research. He joined the group in 1991 and has since worked on issues of risk budgeting, cost of investment constraints, improved measures of risk sensitivities, and optimal risk diversification for portfolios spanning all fixed income asset classes. Hyman helped develop a number of innovative measures that have been broadly adopted by portfolio managers and that have changed standard industry practice. BRUCE D. PHELPS, PHD, is a Managing Director in the Quantitative Portfolio Strategy Group at Barclays Capital Research, which he joined in 2000. Prior to that, he was an institutional portfolio manager and head of fixed income at Ark Asset Management. Phelps was also senior economist at the Chicago Board of Trade, where he designed derivative contracts and electronic trading systems, and an international credit officer and foreign exchange trader at Wells Fargo Bank. Phelps is a member of the editorial board of the Financial Analysts Journal.

• Foreword xviiIntroduction xixNotes on Terminology xxviiPart One Measuring the Market Risks of Corporate BondsChapter 1 Measuring Spread Sensitivity of Corporate Bonds 3Analysis of Corporate Bond Spread Behavior 5A New Measure of Excess Return Volatility 20Refinements and Further Tests 25Summary and Implications for Portfolio Managers 30Appendix: Data Description 34Chapter 2 DTS for Credit Default Swaps 39Estimation Methodology 40Empirical Analysis of CDS Spreads 41Appendix: Quasi-Maximum Likelihood Approach 51Chapter 3 DTS for Sovereign Bonds 55Spread Dynamics of Emerging Markets Debt 55DTS for Developed Markets Sovereigns: The Case of Euro Treasuries 59Managing Sovereign Risk Using DTS 66Chapter 4 A Theoretical Basis for DTS 73 The Merton Model: A Zero-Coupon Bond 74Dependence of Slope on Maturity 77Chapter 5 Quantifying the Liquidity of Corporate Bonds 81Liquidity Cost Scores (LCS) for U.S. Credit Bonds 82Liquidity Cost Scores: Methodology 88LCS for Trader-Quoted Bonds 92LCS for Non-Quoted Bonds: The LCS Model 96Testing the LCS Model: Out-of-Sample Tests 102LCS for Pan-European Credit Bonds 113Using LCS in Portfolio Construction 123Trade Efficiency Scores (TES) 129Chapter 6 Joint Dynamics of Default and Liquidity Risk 133Spread Decomposition Methodology 138What Drives OAS Differences across Bonds? 139How Has the Composition of OAS Changed? 141Spread Decomposition Using an Alternative Measure of Expected Default Losses 145High-Yield Spread Decomposition 147Applications of Spread Decomposition 147Alternative Spread Decomposition Models 150Appendix 152Chapter 7 Empirical versus Nominal Durations of Corporate Bonds 157Empirical Duration: Theory and Evidence 159Segmentation in Credit Markets 173Potential Stale Pricing and Its Effect on Hedge Ratios 173Hedge Ratios Following Rating Changes: An Event Study Approach 179Using Empirical Duration in Portfolio Management Applications 186Part Two Managing Corporate Bond PortfoliosChapter 8 Hedging the Market Risk in Pairs Trades 197Data and Hedging Simulation Methodology 199Analysis of Hedging Results 200Appendix: Hedging Pair-Wise Trades with Skill 208Chapter 9 Positioning along the Credit Curve 213Data and Methodology 214Empirical Analysis 217Chapter 10 The 2007–2009 Credit Crisis 229Spread Behavior during the Credit Crisis 229Applications of DTS 234Advantages of DTS in Risk Model Construction 244Chapter 11 A Framework for Diversification of Issuer Risk 249Downgrade Risk before and after the Credit Crisis 250Using DTS to Set Position-Size Ratios 257Comparing and Combining the Two Approaches to Issuer Limits 260Chapter 12 How Best to Capture the Spread Premium of Corporate Bonds? 265The Credit Spread Premium 266Measuring the Credit Spread Premium for the IG Corporate Index 266Alternative Corporate Indexes 279Capturing Spread Premium: Adopting an Alternative Corporate Benchmark 288Chapter 13 Risk and Performance of Fallen Angels 295Data and Methodology 298Performance Dynamics around Rating Events 303Fallen Angels as an Asset Class 319Chapter 14 Obtaining Credit Exposure Using Cash and Synthetic Replication 337Cash Credit Replication (TCX) 338Synthetic Replication of Cash Indexes 351Credit RBIs 358References 367Index 371

ARIK BEN DOR, PHD, is a Director and Senior Analyst in the Quantitative Portfolio Strategy (QPS) Group at Barclays Capital Research. He joined the group in 2004 after completing a PhD in finance from the Kellogg School of Management. Ben Dor has published extensively in the Journal of Portfolio Management, Journal of Fixed Income, and Journal of Alternative Investments. LEV DYNKIN, PHD, is the founder and Global Head of the Quantitative Portfolio Strategy Group at Barclays Capital Research. Dynkin and the QPS group joined Barclays Capital in 2008 from Lehman Brothers where the group was a part of fixed income research since 1987—one of the longest tenures for an investor-focused research group on Wall Street. JAY HYMAN, PHD, is a Managing Director in the Quantitative Portfolio Strategy Group at Barclays Capital Research. He joined the group in 1991 and has since worked on issues of risk budgeting, cost of investment constraints, improved measures of risk sensitivities, and optimal risk diversification for portfolios spanning all fixed income asset classes. Hyman helped develop a number of innovative measures that have been broadly adopted by portfolio managers and that have changed standard industry practice. BRUCE D. PHELPS, PHD, is a Managing Director in the Quantitative Portfolio Strategy Group at Barclays Capital Research, which he joined in 2000. Prior to that, he was an institutional portfolio manager and head of fixed income at Ark Asset Management. Phelps was also senior economist at the Chicago Board of Trade, where he designed derivative contracts and electronic trading systems, and an international credit officer and foreign exchange trader at Wells Fargo Bank. Phelps is a member of the editorial board of the Financial Analysts Journal.

• Foreword xviiIntroduction xixNotes on Terminology xxviiPart One Measuring the Market Risks of Corporate BondsChapter 1 Measuring Spread Sensitivity of Corporate Bonds 3Analysis of Corporate Bond Spread Behavior 5A New Measure of Excess Return Volatility 20Refinements and Further Tests 25Summary and Implications for Portfolio Managers 30Appendix: Data Description 34Chapter 2 DTS for Credit Default Swaps 39Estimation Methodology 40Empirical Analysis of CDS Spreads 41Appendix: Quasi-Maximum Likelihood Approach 51Chapter 3 DTS for Sovereign Bonds 55Spread Dynamics of Emerging Markets Debt 55DTS for Developed Markets Sovereigns: The Case of Euro Treasuries 59Managing Sovereign Risk Using DTS 66Chapter 4 A Theoretical Basis for DTS 73 The Merton Model: A Zero-Coupon Bond 74Dependence of Slope on Maturity 77Chapter 5 Quantifying the Liquidity of Corporate Bonds 81Liquidity Cost Scores (LCS) for U.S. Credit Bonds 82Liquidity Cost Scores: Methodology 88LCS for Trader-Quoted Bonds 92LCS for Non-Quoted Bonds: The LCS Model 96Testing the LCS Model: Out-of-Sample Tests 102LCS for Pan-European Credit Bonds 113Using LCS in Portfolio Construction 123Trade Efficiency Scores (TES) 129Chapter 6 Joint Dynamics of Default and Liquidity Risk 133Spread Decomposition Methodology 138What Drives OAS Differences across Bonds? 139How Has the Composition of OAS Changed? 141Spread Decomposition Using an Alternative Measure of Expected Default Losses 145High-Yield Spread Decomposition 147Applications of Spread Decomposition 147Alternative Spread Decomposition Models 150Appendix 152Chapter 7 Empirical versus Nominal Durations of Corporate Bonds 157Empirical Duration: Theory and Evidence 159Segmentation in Credit Markets 173Potential Stale Pricing and Its Effect on Hedge Ratios 173Hedge Ratios Following Rating Changes: An Event Study Approach 179Using Empirical Duration in Portfolio Management Applications 186Part Two Managing Corporate Bond PortfoliosChapter 8 Hedging the Market Risk in Pairs Trades 197Data and Hedging Simulation Methodology 199Analysis of Hedging Results 200Appendix: Hedging Pair-Wise Trades with Skill 208Chapter 9 Positioning along the Credit Curve 213Data and Methodology 214Empirical Analysis 217Chapter 10 The 2007–2009 Credit Crisis 229Spread Behavior during the Credit Crisis 229Applications of DTS 234Advantages of DTS in Risk Model Construction 244Chapter 11 A Framework for Diversification of Issuer Risk 249Downgrade Risk before and after the Credit Crisis 250Using DTS to Set Position-Size Ratios 257Comparing and Combining the Two Approaches to Issuer Limits 260Chapter 12 How Best to Capture the Spread Premium of Corporate Bonds? 265The Credit Spread Premium 266Measuring the Credit Spread Premium for the IG Corporate Index 266Alternative Corporate Indexes 279Capturing Spread Premium: Adopting an Alternative Corporate Benchmark 288Chapter 13 Risk and Performance of Fallen Angels 295Data and Methodology 298Performance Dynamics around Rating Events 303Fallen Angels as an Asset Class 319Chapter 14 Obtaining Credit Exposure Using Cash and Synthetic Replication 337Cash Credit Replication (TCX) 338Synthetic Replication of Cash Indexes 351Credit RBIs 358References 367Index 371