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: .
- 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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