Interest rate risk estimation: a new duration-based approach

Emanuele Bajo, Massimiliano Barbi and David Hillier

Applied Economics, 2013, vol. 45, issue 19, 2697-2704

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 article 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.

Date: 2013
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DOI: 10.1080/00036846.2012.667552

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