he hedging literature currently contains many alternative hedging tech-T niques for the management of interest rate risk.' However, there seems to be a strong leaning among bond and assethiability managers toward the use of duration oriented strategies. A duration based hedging model was first presented in the academic literature by Kolb and Chiang (1981) who develop a hedging strategy that matches the price sensitivity of a bond portfolio with a corresponding position in the futures market of equal sensitivity. The purpose of this note is to make their strategy more efficient for actual users by removing a potentially significant bias in their hedge ratio when it becomes necessary to hedge with Treasury bond futures or related "coupon bearing" contracts? The bias occurs when one assumes an 8%, 20-year bond is being priced in the futures contract instead of the "cheapest-todeliver" bond. Kolb and Chiang, although fully aware of this feature, do not discuss how to incorporate this feature into their model. The magnitude and importance of this adjustment is illustrated with a simple example.
Kolb and Chiang present their hedging model in Eq. (3) of their article. They
show that in order to hedge one unit of asset i with financial futures contract j , one should trade N units of j , where N is given by -RjP;D;
where Ri = 1 + the rate expected to obtain on the asset underlying future contract j; Ri = 1 + the expected yield to maturity on asset i; FPi = the price agreed upon in the futures contract j to be paid upon maturity for the futures contract for title to 'For an excellent discussion of the strengths and weaknesses of the most commonly used models, the reader is 'The comments expressed here also apply to the Treasury note and GNMA futures contracts.
referred to Gay and Kolb (1983).