Factor Immunization

Abstract

Immunization is becoming increasingly popular. The idea of adjusting a portfolio of assets in order to reflect the structure of the liabilities of an investor is very appealing to most institutional investors. But hardly any attention is given to the underlying ideas. The principles of bond pricing and the factors that determine the bond prices are central in immunization. One very popular model, Macaulay’s duration matching, uses a very simple structure. The assumptions made in this model are usually banned to footnotes. The model is defended by pointing out the results, compared to more sophisticated models. Good results are defined by deviation from the expected, or desired results. But, as will be pointed out, it is very hard to define the desired result.