ETFs used in experiment
IBND Barclay’s international corporate bond
UUP Powershares U.S. dollar bullish
IEF iShares 7 to 10 year U.S. T-bonds
IBND, UUP, IEF and 50/50 IBND/UUP hedge cumulative returns over time
Correlations
## R.ibnd R.uup R.ief R.hedge
## R.ibnd 1.0000000 -0.9257698 -0.1831580 0.5803914
## R.uup -0.9257698 1.0000000 0.2759456 -0.2294178
## R.ief -0.1831580 0.2759456 1.0000000 0.1228288
## R.hedge 0.5803914 -0.2294178 0.1228288 1.0000000
Sharpe ratio comparisons
## R.ibnd R.uup R.ief R.hedge
## StdDev Sharpe (Rf=0%, p=95%): 0.08818849 0.003000615 0.2378962 0.23349036
## VaR Sharpe (Rf=0%, p=95%): 0.05523954 0.001938056 0.1776780 0.15015662
## ES Sharpe (Rf=0%, p=95%): 0.04061871 0.001579307 0.1420910 0.09680072
Conclusions
- The 7-10 year treasury (
IEF) outperforms a 50/50 hedge of the international corporate bond (IBND) and dollar bullish (UUP). The outperformance is by a factor of 3!
- The correlation between
IBND and UUP is -0.9258. Since the correlation is not exactly -1 there is some risk.
- Sharpe measures the return-to-risk ratio. Higher is better. The sharp ratio of the simple
IEF is higher than that of the hedge.
- If the correlation were exactly -1 (a perfect hedge) theory predicts the risk free rate. Where there is no risk one should expect the risk free rate. This imperfect hedge has risk and a return lower return than our approximate risk-free asset
IEF.
- Let me know when you find two securities with rho=-1 and return greater than the risk free rate. I.e., show me you can beat the simple ’ol
IEF.