Duration and Convexity Gaps: Definition and Hedging
Journal
臺大管理論叢
Journal Volume
6
Journal Issue
2
Pages
159-174
Date Issued
1995
Author(s)
Abstract
In this paper, we extend some of the recently expanded duration gaps by Bierwag and Kaufman (1992) to take into account the price effects of convexity. The expanded duration gaps incorporate futures contracts and swap agreements into the assets/liabilities combinations of depository institutions. Therefore, they are better indicators of the sensitivity of the market value of net worth and economic income to interest rate fluctuations. However, duration measures the percentage change in the market value of a stream of cash flow for a given small change in interest rate. When larger changes are expected, It is necessary to consider convexity to accurately measure the impacts. This is particularly true for depository institutions attempting to create an asset/liability match. After duration and convexity gaps are well-defined, these gaps can be established as targets. And managers can utilize financial futures contracts to affect the target value. In this regards, this paper also propose a simple hedging approach that allows managers to control the interest rate risk implied by the gaps.
Type
journal article