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A New Stochastic Duration Based on the Vasicek and CIR Term Structure Theories
Author(s) -
Wu Xueping
Publication year - 2000
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/1468-5957.00339
Subject(s) - vasicek model , duration (music) , yield curve , bond , term (time) , econometrics , proxy (statistics) , affine term structure model , interest rate , mathematics , maturity (psychological) , economics , statistics , monetary economics , psychology , finance , physics , quantum mechanics , acoustics , developmental psychology
The stochastic duration based on the Vasicek and CIR models is theoretically superior to Macaulay’s duration. However, empirical tests on bond immunization performance have so far failed to show its superiority. Within the one‐factor framework, this paper proposes to use a longer zero‐curve yield instead of the original instantaneous interest rate as a proxy for the relevant risk source(s). We prove that the new duration becomes larger, increasing with bond maturity, than the original duration. Bond immunization using Belgian data shows that the new duration definitely beats the original duration and can in some cases outperform Macaulay’s duration.