Interest Rate Risk Estimation: A New Duration-Based Approach

Posted: 14 Feb 2012 Last revised: 19 Feb 2016

See all articles by Emanuele Bajo

Emanuele Bajo

University of Bologna - Department of Economics

Massimiliano Barbi

University of Bologna - Department of Management

David Hillier

University of Strathclyde - Department of Accounting and Finance

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Date Written: February 14, 2012

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

Suggested Citation

Bajo, Emanuele and Barbi, Massimiliano and Hillier, David, Interest Rate Risk Estimation: A New Duration-Based Approach (February 14, 2012). Applied Economics, Vol. 45, pp. 2697-2704, 2013. Available at SSRN: https://ssrn.com/abstract=2005086

Emanuele Bajo

University of Bologna - Department of Economics ( email )

Bologna
Italy

Massimiliano Barbi (Contact Author)

University of Bologna - Department of Management ( email )

via Capo di Lucca 34
Bologna, 40126
Italy
+39 051 2098404 (Phone)
+39 051 246411 (Fax)

HOME PAGE: http://www.sites.google.com/site/massimilianobarbifinance/

David Hillier

University of Strathclyde - Department of Accounting and Finance ( email )

Curran Building
100 Cathedral Street
Glasgow G4 0LN
United Kingdom
44 0141 330 4809 (Phone)
44 0141 330 4442 (Fax)

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