Interest Rate Risk of Corporate Bond Prices on Bombay Stock Exchange (BSE) –Empirical Test of the Duration, Modified Duration and Convexity

Abstract

Duration and convexity are important measures in fixed-income portfolio management and help develop methodologies in interest rate risk management. This article presents valuation of corporate Bonds on Bombay Stock Exchange (BSE) and empirical test of duration, modified duration and convexity of the corporate bonds at BSE in order to determine sensitivity of bonds prices on interest rate changes. The sensitivity of corporate Bonds in BSE on interest rate changes is tested and determined that convexity is more accurate measure as approximation of bond prices changes than duration. The main goal of this study is to determine how non-linear estimation models fit in case of corporate bonds that are traded on BSE and to verify whether they offer reliable results compared with linear regression model on BSE. Also the most relevant contribution of the paper is to obtain a better curve estimation during the time period of March, 2009 -June, 2012 for duration and convexity exposures that contribute to the marginal increment of the coefficient of determination and the construction of a best nonlinear regression model that overcomes the linearity models.

Keywords: Duration, convexity, corporate bonds, interest rate risk

JEL Classification: G1, G12