Durations of Non-USD Bonds interest, adjust, these, using

JPSem

Does anyone have any thoughts on estimating the duration of non-US denominated bonds, i.e. adjust the raw durations of these bonds to incorporate the FX effect? Would calculating the historical correlation of FX moves and interest rate moves and then adjusting the raw duration using that correlation be one of the options? Thanks.

ohai

What is your definition of "duration" for non-US bonds? Also, are you calculating the payoff in USD? Otherwise, it doesn't seem like you will need FX.

bodhisattva

My definition of "duration" for non-US bonds is the change in the non-USD bond's value in response to 1% change in the U.S. yields. Yes, I am calculating the payoff (returns) in USD, and given that the change in the U.S. rates are not perfectly correlated with the changes in foreign rates (these, in fact, will also be influenced by the FX rates - interest rate parity), I am assuming that I will need to adjust each non-USD bond duration by a factor, which will show the correlation between the U.S. yield curve and non-U.S. curve in question...?

economicz

i guess the question is why are you trying to incorporate the effects of fx in your duration number............seems to be mixinig two concepts into one...............duration analysis and Break even analysis.............

maratikus

Just hedge the principal and interest payments back into USD and calculate the duration based on that.

malbec

Ok. Normally, you would measure duration (US rate sensitivity) and FX deltas separately, particularly since you can hedge these two things independently. As a parallel example, imagine you are pricing some other security like a call option. Call options have rates sensitivity, but you would never include this in the same risk measure as other risk components: delta, vega, etc.

DSquaredSlim

OK, currency hedging will take care of the FX risk, but in terms of managing your duration risk with respect to the change in the U.S. rates, shouldn't there be an adjustment made to the raw duration of the foreign bonds? Say you invest in 10 year Russian zero coupon bond (duration = 10 years), denominated in Russian rubles, and 10 year UST yields go up by 50 bps, your regular duration measure will tell you that your bond will loose ~5% in value, but in reality the pricew of this bond depends mainly on the change in Russian yield curve. So if the Russian yields have, say, +0.7 correlation with the U.S. yields (this is just a made up number, for illustration purpose only), then your bond is actually going to loose 3.5% only. This is the kind of asjustment I am talking about.

cfalevel2011

You're not completely off track, but what you're describing goes beyond the definition of "duration". You're basically trying to infer a predictive relationship between US rates and Russian rates. This is more of a regression analysis than a duration measurement.

bpdulog

I guess you could use US rates as a proxy hedge for Russian rates, but this would probably not be reliable. For instance, in a bearish environment, US rates will probably decline, but Russian (swap) rates might increase due to higher credit spreads.

I think the appropriate answer really depends on what you are trying to do. If you are trying to construct a hedge, then you will probably need to find some kind of Russian rates swap. RUB is non-deliverable, so NDFs might not be a good hedge for Russian rates exposure. If you are trying to write some kind of academic article, then maybe regression analysis is sufficient.

troymo

Well, it is not a "traditional" duration measure, but if you're managing a global bond portfolio then I guess you need to come up with some sort of "adjusted" durations, I assume.