Interest Rate Risk
Overview
Interest Rate risk is the risk that the value of an asset changes due to a change in the market interest rates.
Typically, interest rate risk is considered with respect to fixed income instruments, but it can be applied to
other instruments as well.
Approaches to Interest Rate Risk
The topic of fixed income risk is vast. There are multiple approaches to computing and managing it. For the purposes
of this corner, we categorize approachs into the following groups.
- Statistical:
a statistical approach to fixed income risk views the value of the portfolio in the future as being a random variable and
subject to standard statistical analysis.
Statistical models include
- Sensitivity Based:
seeks to establish the relationship between the value of a fixed income and certain exongenous variables, such as the interest rate.
(see sensitivity analysis)
This type of analysis would let you know how much you stand to profit or lose from a certain hypothesized change in the intereset rate.
While not inherently statistical, it can be married with the statistical approach by specifying a statistical distribution for underlying
variables, for the sensitity would then give you statistical information about the top level portfolio.
Sensitivity based measures include:
