Handbook of Finance: Valuation, Financial Modeling, and Quantitative Tools

Chapter 21. Yield Curve Risk Management

ROBERT R. REITANO, PhD, FSA

Professor of the Practice in Finance, Brandeis University, International Business School

Abstract: Yield curve risk management pertains to the general discipline of controlling the sensitivity of a portfolio of fixed income securities and derivatives to changes in one or more interest rates, spreads or yield curves. In general, the purpose for wanting this control can be defensive or offensive, strategic or tactical, but in virtually all such cases the sensitivity of the given portfolio is being controlled relative to the sensitivity of a second "target" fixed income portfolio. Independent of the objective of the yield curve risk management program, the first challenge is one of quantifying the interest rate sensitivities of the given fixed income and target portfolios. The second challenge is to develop yield curve models appropriate to the application The final challenge is either one of developing defensive risk management strategies from a longer term model of yield curve movements, or developing opportunistic tactics to capitalize on shorter term expectations.

Keywords: yield curve risk management, defensive risk management, single-factor models, Macaulay duration, partial durations, durational leverage, key rate durations, multifactor yield curve models, principal components, immunization, stochastic immunization, spread duration, spread leverage, multivariate duration

In asset/liability management as well as ...