Lesson 5 of 5 · 13 min

Portfolio duration and convexity

In practice, a portfolio's duration and convexity are the market-value-weighted averages of its bonds' measures: easy to use, but valid only for parallel yield-curve shifts.

In short

  • Two methods: (1) treat the portfolio's aggregate cash flows as one bond and use their weighted-average time to receipt; (2) take the weighted average of the individual bonds' durations and convexities.
  • Method 1 is theoretically correct but hard to use in practice. Method 2 is what portfolio managers commonly use.
  • Weights are each bond's share of total market value (full value), not par value.
  • Plug portfolio duration and convexity into the same estimate: −DPΔy+12CP(Δy)2-D_P \Delta y + \tfrac{1}{2} C_P (\Delta y)^2.
  • The weighted-average approach implicitly assumes a parallel shift: every bond's yield moves by the same amount. Real curves often steepen, flatten or twist.
  • It is more accurate when the bonds' yields are close to each other and the yield curve is flat.

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Portfolio duration and convexity · Yield-Based Bond Convexity and Portfolio Properties