Interpreting and Using Advanced Risk Measures

Wesley Phoa, Ph.D.

Common measures of risk, such as duration, convexity and "key rate" durations, focus on interest rate risk: the sensitivity of security or portfolio returns to changes in the level or shape of the Treasury yield curve. However, it is critical for bond investors to identify and quantify other sources of risk.

This is particularly true for investors whose performance is measured against a bond index, and for investors matching liabilities resulting in cashflow profile constraints. When an investor relies mainly on sector outperformance strategies, the traditional risk measures may not explain relative performance.

BondEdge has implemented four advanced risk measures which all measure essential determinants of relative return. They capture the following risk categories:

1. Volatility risk
2. Prepayment model risk
3. Zero volatility spread
4. Spread duration

For all investors holding corporate bonds, mortgage-backed securities and/or structured products -- regardless of investment strategy -- these are key areas of risk.