Interest rate risk estimation: a new duration-based approach

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Duration is widely used by fixed income managers to proxy the interest rate risk of their assets and liabilities. However, it is well known that the convexity of the price-yield relationship introduces approximation errors that grow with changes in yield. In this article we suggest a new approach, ‘discrete duration’, which significantly improves upon the accuracy of traditional duration methods and achieves a level of accuracy close to the more complex ‘duration-plus-convexity’ measure. In particular, discrete duration performs particularly well for long dated and low coupon rate bonds where the estimation error is impressively close to zero.

Keywords: G10; G12; duration; fixed income; hedging; interest rate risk

Document Type: Research Article


Affiliations: 1: Department of Management,University of Bologna, via Capo di Lucca,34, Bologna 40126, Italy 2: Department of Accounting and Finance,Strathclyde Business School, Glasgow,Scotland, UK

Publication date: July 1, 2013

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