lcw77

The hedge is better with the 2-bond than the duration hedge. For the investor , a hedge is supposed to preserve the value when rates increase . so a smaller duration is a better duration under the circumstances. ( remember duration measures the loss in value of the price of the security for a small move in rates ). A reduction of 9% in duration is a big advantage in times of rising rates.

The duration hedge pays off better on the side of declining rates , when prepayments increase. But this advantage is small compared to the carry in the security ( i.e. the gain in the value of the security as rates fall )

The 2-bond loses a little more for declines but offsets the loss in principal better on the side of higher interest rates. In fact the duration change is almost nullified