Capital gains sensitivity of U.S. BBB-rated debt: a Markov-switching application

In a joint paper with Ilias Chondrogiannis, Marya studies interest rate sensitivities of U.S. investment grade BBB-rated bonds over 2001–2016. Their methodology assesses capital gains of risk-free government bond portfolios and relatively risky BBB-rated bond portfolios using average coupon and blended yield indices for U.S. market. They present empirical evidence of regime switching from a positive sensitivity of U.S. BBB-rated bonds, observed under the normal conditions, to a negative one during economic distress and vice-versa. According to a Markov switching model, the switch is on the means. They address an interrelation between interest rate and creditworthiness of issuers and show that it undergoes structural changes depending on a maturity stage of the business cycle. It allows them to plausibly explain the observed binarity behavior of interest rate sensitivity. This research enriches theoretical rationale of interest rate risk management and shed light on how banks and financial institutions may approach strategies to hedge downside risk.