A Guide to Fixed Income Portfolio Management Using RiskDuration, RewardDuration, and DurationRatio as Alternatives to Effective Duration and Convexity

23 Pages Posted: 5 Nov 2007 Last revised: 22 Jun 2016

See all articles by Mike Allen

Mike Allen

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: October 15, 2007

Abstract

A very important goal of a fixed income portfolio manager is to accurately measure and manage interest rate risk (and reward), which comes in the form of percentage price changes from current market prices. This is the focus of this paper, mainly pertaining to callable or pre-payable bonds. Macaulay's duration (a.k.a. "duration") and modified duration are not effective risk management measurements on callable bonds like they are on non-callable bonds. "Effective duration" is useful on callable bonds, HOWEVER, is useless by itself. Convexity MUST be combined with effective duration to be of value. Effective duration and convexity combined, though technically accurate, are very difficult to interpret and apply. Alternatives to effective duration and convexity that offer the same valuable risk management information, but in a much simpler and usable form are RiskDuration, RewardDuration, and DurationRatio. RiskDuration is defined as the percentage price change of a bond due to a shift up in general market interest rates. RewardDuration is defined as the percentage price change of a bond due to a shift down in general market interest rates. DurationRatio is defined as RewardDuration divided by RiskDuration. RiskDuration and DurationRatio are the two most powerful statistics available to today's fixed income portfolio managers.

Note: This is a condensed version of http://ssrn.com/abstract=1024296

Keywords: RiskDuration, RewardDuration, DurationRatio, Macaulay duration, modified duration, duration, convexity, Allen's convexity, quality ratio, fixed income portfolio management, bond management, risk management

Suggested Citation

Allen, Mike, A Guide to Fixed Income Portfolio Management Using RiskDuration, RewardDuration, and DurationRatio as Alternatives to Effective Duration and Convexity (October 15, 2007). Available at SSRN: https://ssrn.com/abstract=1027022 or http://dx.doi.org/10.2139/ssrn.1027022

Mike Allen (Contact Author)

affiliation not provided to SSRN ( email )

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