Equity Duration and Portfolio Risk Management

The authors adopt the perspective of a portfolio manager simultaneously holding long and short equity positions and investigate whether portfolio standard deviation is reduced by calibrating the overall portfolio duration to be zero. Although numerous studies have suggested that equity duration may...

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Bibliographic Details
Published inJournal of Investing Vol. 26; no. 3; pp. 29 - 40
Main Authors Broughton, John B., Lobo, Bento J.
Format Journal Article Trade Publication Article
LanguageEnglish
Published London Pageant Media 01.10.2017
Subjects
Bond portfolios
Book value
Cash flow forecasting
Discount rates
Discounted cash flow
Earnings per share
Equity
Estimates
Growth rate
Inflation rates
Interest rate risk
Interest rates
Investment policy
Portfolio management
Rates of return
Residuals
Risk management
Stock prices
Studies
Yield to maturity
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Summary:The authors adopt the perspective of a portfolio manager simultaneously holding long and short equity positions and investigate whether portfolio standard deviation is reduced by calibrating the overall portfolio duration to be zero. Although numerous studies have suggested that equity duration may be useful in portfolio risk management, this study directly tests this proposition. The authors first identify some methodological issues involved with measuring equity duration and then explore the use of equity duration as a tool in portfolio risk management. They present strong evidence that equity duration can be used in equity portfolios to reduce volatility and introduce a novel test that involves the comparison of market-neutral portfolios that are duration hedged with those that are duration exposed. Portfolio standard deviations form a "volatility smile" that reaches a minimum when duration is fully hedged. The results suggest that duration may be measuring risk not captured by beta.
ISSN:1068-0896
2168-8613
DOI:10.3905/joi.2017.26.3.029