Insurers match the cash flows of typically illiquid insurance liabilities, such as
in-force annuities, with government and corporate bonds. As they intend to buy
corporate bonds and hold them to maturity, they can capture the value attached to
liquidity, without running the market liquidity risk that is associated with having
to sell bonds in the open market. During the long consultation period dedicated to
the mark-to-market valuation of insurance assets and liabilities for the Solvency II
regulatory framework, CEIOPS noted the importance of the accurate breakdown of
the credit spread into its components, most notably the credit and non-credit (i.e.
liquidity) components. In this thesis we review many modelling efforts to isolate the
liquidity premium and propose a reduced-form modelling approach that relies on a
new, relative liquidity proxy.
Challenging the status quo when it comes to active and passive investment strategies,
products and funds, Exchange Traded Funds and `smart-beta' products provide
investors with straightforward ways to strategically expose a portfolio to risk drivers,
raising the bar for traditional investment funds and managers. In this thesis, we
investigate how traditional sources of equity outperformance (alpha), such as small
caps, low volatility and value, translate to UK corporate bonds. For automated
trading strategies in corporate bonds, and those with specific factor exposure requirements
in particular, transaction costs, rebalancing and an optimal turnover
strategy are crucial; these aspects of building factor portfolios are explored for the
UK market.
Since the financial crisis, mathematical models used in finance have been subject
to a fair amount of criticism. More than ever has this highlighted the need
of better risk management of financial models themselves, leading to a surge in
`model validation' roles in industry and an increased scrutiny from regulatory bodies.
In this thesis we look at stochastic credit models that are commonly used by
insurers to project forward credit-risky bond portfolios and the model uncertainty
and parameter risk that arises as a result of relying on published credit migration
matrices. Specifically, our investigation focuses on two violations of the Markovian
process that credit transitions are assumed to follow and statistical uncertainty of
the migration matrix
