BOND MATH: The Theory Behind the Formulas

Immunization Implementation Issues

Immunization theory is based on the big-bundle-of-cash-flow portfolio statistics. In the example, we “lock in” the cash flow yield of 3.839% over the 12-year horizon because the portfolio Macaulay duration is 11.817. But that duration statistic is not commonly used in practice; instead it typically is estimated using the market-value-weighted average of the individual yield durations. In Chapter 9, we calculated AvgMacDur(Yield) to be 10.867, considerably below the “true” portfolio duration because of the steep upward slope to the yield curve.

Bond strategies in practice inevitably have some degree of model risk arising from the statistics that we use to structure and manage the portfolio. Typically, we estimate ...