Scenario modeling for the management of international bond portfolios

We address the problem of portfolio management in the international bond markets. Interest rate risk in the local market, exchange rate volatility across markets, and decisions for hedging currency risk are integral parts of this problem. The paper develops a stochastic programming optimization model for integrating these decisions in a common framework. Monte Carlo simulation procedures, calibrated using historical observations of volatility and correlation data, generate jointly scenarios of interest and exchange rates. The decision maker's risk tolerance is incorporated through a utility function, and additional views on market outlook can also be incorporated in the form of user specifi…