Damir Filipovic (EPFL & SFI): Shrinking the Term Structure

Shrinking the Term Structure

Damir Filipovic (EPFL and Swiss Finance Institute)

Abstract: We develop a conditional factor model for the term structure of Treasury bonds, which unifies non-parametric curve estimation with cross-sectional asset pricing. Our factors are investable portfolios and estimated with cross-sectional ridge regressions. They correspond to the optimal non-parametric basis functions that span the discount curve and are based on economic first principles. Cash flows are covariances, which fully explain the factor exposure of coupon bonds. Empirically, we show that four factors explain the discount bond excess return curve and term structure premium, which depends on the market complexity measured by the time-varying importance of higher order factors. The fourth term structure factor capturing complex shapes of the term structure premium is a hedge for bad economic times and pays off during recessions.

Bio: Damir Filipovic holds the Swissquote Chair in Quantitative Finance at the Ecole Polytechnique Federale de Lausanne (EPFL) and a Swiss Finance Institute Senior Chair. He also acts as head of the Swiss Finance Institute at EPFL. He has been a faculty member of the University of Vienna, the University of Munich and at the ORFE Department at Princeton University. He received his PhD in Mathematics from ETH Zurich. He also worked for the Swiss Federal Office of Private Insurance as co-developer of the Swiss Solvency Test. His research focus is in quantitative finance and risk management. His papers have been published in a variety of academic journals including the Journal of Finance, Journal of Financial Economics, Mathematical Finance, Finance and Stochastics, and the Annals of Applied Probability. He is on the editorial board of several academic journals including Mathematics and Financial Economics, Stochastics, Asia-Pacific Financial Markets, Mathematical Finance, Finance and Stochastics, SIAM Journal on Financial Mathematics, Stochastic Processes and Their Applications and European Actuarial Academy Series. He is the author of a textbook titled Term-Structure Models. He was President of the Bachelier Finance Society. He was awarded the Louis Bachelier Prize, the AXA-EGRIE Prize at World Risk and Insurance Economics Congress and the prize of the Dimitris N. Chorafas Foundation.