Immunization Using a Parametric Model of the Term Structure
AbstractIn this paper, we develop a new immunization model based on a parametric specification of the term structure of interest rates. The model extends traditional duration analysis to account for both parallel and non-parallel term structure shifts that have an economic meaning. Contrary to most interest rate risk models, we analyse both first-order and second-order conditions for bond portfolio immunization and conclude that the key to successful protection will be to build up a bond portfolio such that the gradient of its future value is zero, and such that its Hessian matrix is positive semidefinite. In addition, we provide explicit formulae for new parametric interest rate risk measures and present alternative approaches to implement the immunization strategy. Furthermore, we provide useful expressions for the sensitivity of interest rate risk measures to changes in term structure shape parameters.
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Bibliographic InfoPaper provided by University of Évora, Department of Economics (Portugal) in its series Economics Working Papers with number 19_2005.
Length: 32 pages
Date of creation: 2005
Date of revision:
Immunization; duration; parametric model; interest rate risk;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-12-09 (All new papers)
- NEP-FIN-2005-12-09 (Finance)
- NEP-MAC-2005-12-09 (Macroeconomics)
- NEP-MON-2005-12-09 (Monetary Economics)
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