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An accurate formula for bond‐portfolio stress testing

Leonard Tchuindjo (Capital Markets Pricing Group – Fannie Mae, Washington, DC, USA)

Journal of Risk Finance

ISSN: 1526-5943

Article publication date: 23 May 2008

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

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Emerald Group Publishing Limited

Copyright © 2008, Emerald Group Publishing Limited