An Improved Immunization Strategy: M-Absolute

Abstract:     
The traditional duration model has limited power for protecting against interest rate risk. A new risk measure, entitled M-Absolute, is designed to provide powerful and practical single-risk-measure immunization in particular circumstances. M-Absolute is similar to M-Square but is derived as a first-order interest-rate-risk hedging model. M-Absolute of a bond is defined as the weighted average of the absolute distances of the bond's cash flows from a horizon point. Even though it is a single-risk measure, M-Absolute can act effectively to reduce the impacts of several types of interest rate risks rather than hedge against only a single type of term structure shift. Empirical tests show that M-Absolute reduces the interest rate risk inherent in the traditional duration model by more than half. These results are independent of the particular time period chosen.

Keywords: Duration, Convexity, M-Absolute, M-Square, Interest Rate Risk, Hedging

JEL Classifications: G11, G12, G13, G21, G22, G23, G24

Working Paper Series