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Interest Rate Risk Estimation: A New Duration-Based ApproachEmanuele BajoUniversity of Bologna - Department of Management Massimiliano BarbiUniversity of Bologna - Department of Management David HillierUniversity of Strathclyde, Glasgow - Department of Accounting and Finance February 14, 2012 Applied Economics 45, 2697-2704 Abstract: 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 paper 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: Duration, Interest Rate Risk, Hedging, Fixed Income JEL Classification: G10, G12 Accepted Paper SeriesDate posted: February 14, 2012 ; Last revised: July 10, 2012Suggested CitationContact Information
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