Let's say we have an 11-year off-the-run Treasury bond, but we only have access to on-the-run Treasury bonds. How do we hedge?
$\begingroup$ Hi velen, welcome to quant.se! Can you make your question more precise by telling what exactly you wanna hear? Can you give an example? This will probably lead to better and faster answers=) $\endgroup$– Stefan VoigtOct 21, 2015 at 12:10
$\begingroup$ It is difficult, you can hedge with an on the run bond plus something that is correlated with the on-the-run-off-the run basis, what that "thing" could be, I don't know. $\endgroup$– nbbo2Oct 22, 2015 at 17:43
1$\begingroup$ Don't feel bad, even John Meriwether couldnt' figure this one out. $\endgroup$– Alex COct 23, 2015 at 3:08
As the manager of a mutual fund (not a hedge fund) you can only short treasury futures. So you take the one that is clostest in duration, look for an optimal hedge ratio and that's it.
In my experience you have to leave liquidity risk open.