An accurate formula for bond‐portfolio stress testing
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
Citation
Tchuindjo, L. (2008), "An accurate formula for bond‐portfolio stress testing", Journal of Risk Finance, Vol. 9 No. 3, pp. 262-277. https://doi.org/10.1108/15265940810875586
Publisher
:Emerald Group Publishing Limited
Copyright © 2008, Emerald Group Publishing Limited