The Duration Derby: A Comparison of Duration Based Strategies in Asset Liability Management

Zheng, Harry; Thomas, Lyn C.; Allen, David E.

doi:10.2139/ssrn.266690

Cited by 4 publications

(6 citation statements)

References 7 publications

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“…For this, when it comes to the calculation of Macaulay duration, there are always two situations: zero-coupon bond and coupon bond. The Macaulay duration of a zerocoupon bond equals its time to maturity in most cases because the zero-coupon bond is a bond that pays no interest which trades at a discount to its face value, so with only one payment, the average time until payment must be the bond's maturity [9].…”

Section: Macaulay Durationmentioning

confidence: 99%

Analysis of Bond Investment based on Immune Strategy

Lu¹

2022

Proceedings of the 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022)

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Interest rate risk is the essential market risk faced by bond investment, mainly the price effect and reinvestment effect. With the acceleration of interest rate liberalization, the importance and urgency of interest rate risk management of bond investors are increasingly prominent. Moreover, as an essential method of immunity against interest rate risk, the duration immunity strategy has been widely used. This paper starts with the most basic concept of bond duration, using a specific case analysis. Through the calculation to build a reasonable bond portfolio, we find the risk immunization of the duration immune strategy regarding the sudden interest risk. Moreover, during the case study, we also had limitations of the immune strategy applications in the natural bond markets. Finally, we conclude the whole finding and then decide the next research direction.

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Section: Macaulay Durationmentioning

confidence: 99%

Analysis of Bond Investment based on Immune Strategy

Lu¹

2022

Proceedings of the 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022)

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“…Since prepayment risk affects the timing of the lender's cash inflows, it also impacts on her management of interest rate risk. For instance, banks actively involved in asset-liability management will target specific durations on debt instruments in order to match the interest rate risk exposure of their assets and liabilities (see, e.g., Zheng et al 2003). This matching is jeopardized by prepayment risk, because banks as callable bond traders compute the duration of their callable assets using the optimal refinancing policy of these instruments.…”

Section: A Formal Definition Of Prepayment Riskmentioning

confidence: 99%

Prepayment risk on callable bonds: theory and test

François

Pardo

2015

Decisions Econ Finan

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We develop a framework for analyzing prepayment risk on defaultable callable bonds. We argue that prepayment risk emanates from the following informational asymmetry: Callable bond traders cannot determine the issuer's firm valuemaximizing call policy, and their best anticipation is the optimal refinancing policy given by a term structure model. We show that, from the callable bond holder perspective, the issuer's departure from the optimal refinancing policy translates into an accrued exposure to market risk. The prepayment risk magnitude represents this risk transfer, and we show that callable bond traders can infer it from observable bond characteristics. Tests on callable bond transaction data provide strong evidence for prepayment risk and validate our conjecture that insurance companies trade callable bonds to reduce their exposure to prepayment risk magnitude.

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“…The first approach is discussed by Ho (1997), Rzadkowski and Zaremba (2000), etc. The second approach is investigated by Zheng, Thomas, and Allen (2003), Vinter and Zheng (2003). We first review the idea of the second approach to general rate changes.…”

Section: Nonparametric Duration Measuresmentioning

confidence: 99%

“…It is undecided only when i≤i0 w i = i≥i0+1 w i , but that relation is transient since the weights w i change continuously as time t passes by. The optimal solution D a is the same as the approximate duration, an interest rate risk measure discussed in Zheng, Thomas, and Allen (2003) in comparing duration-based immunization strategies.…”

Section: Nonparametric Duration Measuresmentioning

confidence: 99%

“…The optimal solution of a minimum M-absolute portfolio is unstable in the sense that it can easily choose bonds of very different durations with a small change of data. Zheng, Thomas, and Allen (2003) suggest an alternative interest rate risk measure, called approximate duration, for regular bonds in order to address the model misspecification risk. The approximate duration measures the bond price sensitivity to rate changes without assuming prior any particular patterns of rate changes.…”

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Macaulay durations for nonparallel shifts

Zheng

2006

Ann Oper Res

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Macaulay duration is a well-known and widely used interest rate risk measure. It is commonly believed that it only works for parallel shifts of interest rates. We show in this paper that this limitation is largely due to the traditional parametric modelling and the derivative approach, the Macaulay duration works for non-parallel shifts as well when the non-parametric modelling and the equivalent zero coupon bond approach are used. We show that the Macaulay duration provides the best one-number sensitivity information for non-parallel interest rate changes and that a Macaulay duration matched portfolio is least vulnerable to the downside risk caused by non-parallel rate changes under some verifiable conditions. AMS Classification 65K10 . 90C90Macaulay duration is a well-known interest rate risk measure for a portfolio of regular bonds (options-free and default-free). It measures the percentage change in portfolio value due to the instantaneous change in interest rates. It also defines a portfolio immunization horizon over which the portfolio value remains immunized from an instantaneous shock in interest rates. A simple strategy in immunization is to match the present value and the Macaulay duration of an asset portfolio with those of the liability. The portfolio is then immunized to instantaneous small parallel movements in yields (the whole yield curve is shifted up or down by the same increment). A dynamic strategy (continuous rebalancing) is needed to keep the portfolio immunized against small parallel shifts.The main criticism to the Macaulay duration is that it is valid only to small parallel shifts. Much effort has been made to extend it to non-parallel shifts. Some other durations have been suggested, for example, log-stochastic process duration (Khang, 1979) when shortterm rates are more volatile than long-term rates, key-rate duration (Ho, 1992) when there

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The Duration Derby: A Comparison of Duration Based Strategies in Asset Liability Management

Cited by 4 publications

References 7 publications

Analysis of Bond Investment based on Immune Strategy

Analysis of Bond Investment based on Immune Strategy

Prepayment risk on callable bonds: theory and test

Macaulay durations for nonparallel shifts

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