| Because of the serious consequences of interest rate volatility, interest rate risk management and immunization are important topics of academic research and practitioner concern. Many single- and multiple-risk-measure models have been proposed and implemented to control interest rate risk exposure. Single-risk-measure models such as duration are relatively easy to implement but are often of insufficient power in their immunization performance or interest rate risk protection. Multiple-risk-measure models have been developed to improve performance relative to single-risk-measure models. They can be difficult to implement, however. For example, even if the user is sophisticated enough to understand and implement a multiple-risk measure model in the case of simplified, default-free cash securities, with more-complex securities, the user may be unable to measure accurately or to properly incorporate the multiple-risk measures. These problems can be especially severe with higher order risk measures.Just because of the traditional duration model has limited power for protecting against interest rate risk. A new risk measure, entitled M-Absolute, is designed to provide powerful and practical single-risk-measure immunization in particular circumstances. M-Absolute is similar to M-Square but is derived as a first-order interest-rate-risk hedging model. M-Absolute of a bond is defined as the weighted average of the absolute distances of the bond's cash flows from a horizon point. Even though it is a single-risk measure, M-Absolute can act effectively to reduce the impacts of several types of interest rate risks rather than hedge against only a single type of term structure shift. The single-risk-measure immunization model, M-Absolute, that is both simple and powerful. The model is simple in that only one risk measure is used to manage interest rate risk. The model is powerful in that it reduces by more than half the interest rate risk inherent in the traditional duration model. |
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