Measuring the performance of government bond portfolios with index‐based level, slope, and curvature factors

Abstract This paper introduces a three‐factor interest rate risk model to improve the measurement of active bond fund performance. Traditional models assume a linear relationship between risk exposure and expected returns, leading to biases. By incorporating level, slope, and curvature factors derived from Treasury index returns, the proposed model better captures the nonlinear nature of bond returns. Empirical tests on passive and active US government bond portfolios confirm its accuracy in estimating passive style returns and active alpha. The study also provides the first performance analysis of fixed‐income separate accounts, revealing their economic significance and superior value‐added performance over mutual funds.