Assessing Interest Rate Risk Beyond Duration - Shift, Twist, Butterfly

Apr 20, 2010

High fiscal deficits, a sharp rise in the issuance of sovereign debt from major developed economies, rising inflation expectations, and possible changes in central bank rates could cause the yield curves from around the world to change significantly. This poses challenges for fixed income professionals who need to address possible non-parallel changes to the term structure. This paper illustrates the capabilities of Shift-Twist-Butterfly (STB) factor models to help address these challenges. We provide a longer-term perspective on term structure changes in the Euro zone, US and Japan. Through four portfolio case studies, we show that the use of risk measures, such as duration, convexity or key rate durations, has limitations. These can be overcome by the complementary use of advanced fixed income risk models based on STB interest rate risk factors.