PCA Interpretation

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Joined: Thu Aug 08, 2013 8:02 am

PCA Interpretation

Postby asimakoa » Thu Aug 08, 2013 1:44 pm

Dear Dr Alexander,
I am an IR trader and I am using the classic PV01 method to calculate my Delta risk to each point of the swap curve. I have recently applied PCA to have and a view of my exposure to the 3 major curve movements. I have used your notes and the workbook “PCA_Monthly” (that I found at the web).
At worksheet “VaR” you use as an input a “PVO1 column” and the three main eigenvectors to find:
Net sensitivities
P1 P2 P3
£8,056 -£15,264 -£167

Question: If I put at PCA_Monthly workbook/VaR worksheet/PV01 Column" my PVO1 possition in swaps EG:
Term PVO1
1y 5,000
2Y -2,000
3y -5,000
4y -5,000
5y 16,000
30y -5,000
Where, the meaning is that I will make 16,000eur if 5y swap increases by 0.01%, and I will loose 2,000eur if 2y swap increases by 0.01%... ext...

What will be the meaning of the calculated Net Sensitivities in terms of sign and absolute value? To be more specific suppose that i find:

P1 P2 P3
4,000eur -18,000eur 2,000eur

1) Does it mean that I will make money if I have a parallel movement defined by first eigenvector?
2) If yes does the absolute value of 4,000 informs me of the size of that amount?
3) Moreover, If i draw the first factor i see the move of the swap curve that it implies. However, I have no clue regarding the range of the move that it implies as at y'y axis I have the eigen vector components and no basis points... So, how do i proceed ?

Please do not refer me to a page of your books as I do not have them (but I am about to buy them).
If apart from you another member of the forum can answer (or comment) my post I would be very glad.

Professor, sorry for my long question.
Many thanks in advance and congratulations for your well known forum.

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