Exponential Duration: A More Accurate Estimation of Interest Rate Risk

Abstract

We develop a new method to estimate the interest rate risk of an asset. This method is based on modified duration and is always more accurate than traditional estimation with modified duration. The estimates by this method are close to estimates using traditional duration plus convexity when interest rates decrease. If interest rates rise, investors will suffer larger value declines than predicted by traditional duration plus convexity estimate. The new method avoids this undesirable value overestimation, and provides an estimate slightly below the true value. For risk-averse investors, overestimation of value declines is more desirable and conservative.

Keywords: Duration, interest rate risk

JEL Classification: G10, G12