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CT1 Effective Duration

B

Bharti Singla

Senior Member
Ch.-14, Effective Duration (pg 20)
The effective duration is a measure of the rate of change in value of A with i. It means it measures the change in present value of payments with respect to change in interest rate. But at the bottom of pg23 it is written that 'Both the volatility/effective duration and DMT provide a measure of AVERAGE LIFE of an investment'. Yes, I agree DMT measures the average life but how Volatility provide a measure of average life?
Please anyone clarify
Thanks
 
Bharti Singla said:
Ch.-14, Effective Duration (pg 20)
The effective duration is a measure of the rate of change in value of A with i. It means it measures the change in present value of payments with respect to change in interest rate. But at the bottom of pg23 it is written that 'Both the volatility/effective duration and DMT provide a measure of AVERAGE LIFE of an investment'. Yes, I agree DMT measures the average life but how Volatility provide a measure of average life?
Please anyone clarify
Thanks
Click to expand...

you can see at the bottom of the page20 value of (-A'/A) is same as DMT in pg 21..you have to open n write the formula of present value of A and A' in terms of vtk,tk,Ctk...so both can be used to measure average life of an investment.
 
DMT is the average time weighted by the PVs.

volatility = v * DMT and so is a nearly a weighted average.

I prefer to think of volatility as the rate of change in the PV for a change in the interest rate.
 
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