15 Dec

Duration and Convexity solved example: The foundation of an ALM (Asset Liability Management) model

Duration & Convexity Calculation Example

While mathematically speaking duration and convexity are simple topics, somehow Risk heads and Quants in general have a difficult time explaining both to retail banking, senior executive teams and board members. I thought a working example of duration and convexity illustrating the differences between Macaulay, Modified and Effective Duration side by side with an illustration of Convexity would help the cause. We may still lose the battle for hearts and minds when it comes to these two topics but we would know that we had tried.

In the posts that follow we will look at the specific mechanics of the Duration (i.e. Macaulay Duration, Modified Duration and Effective Duration) and Convexity calculations.

Duration, Convexity calculation example: Working with Macaulay & Modified Duration
Duration, Convexity Calculation Example: Working with Effective Duration
Duration, Convexity Calculation Example: Working with Convexity and Sensitivity
Interest Rate Risk: Convexity
Duration, Convexity and Asset Liability Management – Calculation reference

For a more advanced understanding of Duration & Convexity and its application in a banking setting please see the Asset Liability Management – The ALM Crash course and survival guide.

If you would like to buy this example as an excel file, please see the Computational Finance section at our online finance course store. The online finance course store  includes easy-to-read-and-work-with downloadable pdf files, excel templates and ready-to-work with models that are shared to illustrate usage and speed up learning for advanced financial modeling, forecasting and simulation topics including interest rate forecasting and simulation, value at risk analysis, credit analysis and processes, Internal Capital Adequacy Assessment Process (ICAAP), asset liability management and other related middle office and risk and computational finance topics.