Bond laddering and bond indexing

Abstract

Bond laddering and bond indexing have been widely accepted approaches to bond investing among retail investors. However, bond laddering has virtually been ignored in both the academic literature and most of the popular investment textbooks. One thing both approaches have in common is that they are passive strategies with no attempt whatsoever to beat the market. There are many unresolved issues about the two seemingly similar approaches. First, which approach should an investor favor? Is there any room for both to be used at the same time? Second, if an investor decides to use a ladder, what is the appropriate term to maturity for the ladder? There is hardly any theoretical or empirical guidance as to which is a better approach to use and the right term of a ladder. The relative attractiveness of the above two approaches are empirically examined in this study. We identify conditions that favor one over the other. Conditions under which both instruments should be held within an optimal portfolio are also identified. We also identify conditions in which a longer term ladder is more appropriate than a shorter term ladder.