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CFA Level I · CFA Level I Exam · Curve-Based and Empirical Fixed-Income Risk Measures

A portfolio manager observes that during periods of market stress, the yield volatility of low-rated corporate bonds rises much more than that of government bonds. Which implication for using analytical duration to estimate price changes is most likely correct?

Analytical duration is likely to understate price risk for low-rated bonds in stress, because credit spreads widen and yields change by more than the benchmark. The measure does not capture this yield relationship, which empirical duration, using observed data, would reflect.

  1. AAnalytical duration becomes more reliable because stressed yields move in parallel
  2. BAnalytical duration is likely to understate price risk because credit spreads widen along with benchmark yield changesCorrect
  3. CAnalytical duration is unaffected because duration depends only on coupon and maturity

Explanation

In stress, spreads on low-rated bonds widen and correlate with benchmark moves, so yields change by more than the benchmark. Analytical duration assumes a given yield change and misses this, understating risk. The parallel-shift claim is contradicted by the differing volatilities.

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