An accurate formula for bond‐portfolio stress testing

Leonard Tchuindjo

Journal of Risk Finance, 2008, vol. 9, issue 3, 262-277

Abstract: Purpose - The purpose of this paper is to derive an easy‐to‐implement and highly accurate formula to approximate the change in the bond price resulting from a change in interest rates. Design/methodology/approach - The bond price is raised to an infinitesimal power and the Taylor series expansion is applied. Then, using the well‐known modified duration and convexity, the new formula is obtained as a limiting case. Findings - It is proved mathematically and illustrated by numerical examples that the new formula generates better results than both the traditional duration‐convexity and the exponential duration approximation formulas. Originality/value - The new formula derived in this paper will be used by risk managers to perform stress‐testing on bond portfolios.

Keywords: Risk management; Bonds; Interest rates; Mathematics (search for similar items in EconPapers)
Date: 2008
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jrfpps:15265940810875586

DOI: 10.1108/15265940810875586

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