Empirical Duration and High Yield Bonds - Fixed Income


Not sure to have understood why is the empirical duration less than the modified duration?

and why is the empirical duration at his highest for high yield bonds?

When benchmark yields increase, credit spreads tend to narrow (more for HY bonds than for IG bonds). When benchmark yields decrease, credit spreads tend to widen (more for HY bonds than for IG bonds).

Thus, the yield change seen by credit bonds tends to be less than the yield change in the benchmark (par) rate, which means that the price change is less than expected, which means that the empirical duration is less than expected.


so can we say this is good that the actual sensitivity to interest rate changes in a credit bond is much lesser than what we assumed it to be?

I guess the empirical duration has a major impact on the HY bond for the simple reason that the credit spread change dominates more than the change in the benchmark yield?

That depends on how you measure “good”.

The price volatility will be lower, and the return volatility will likely be lower, which many investors would consider to be good.

However, that also means that the highest possible price will likely be lower, which many investors would consider to be bad.


ok, empirical duration we said that based on the regression that we run we find that it is actually lower than the modified duration.
But do we have a scenario where the empirical duration turns out to be higher than the modified duration

If, for some reason, a bond’s spread widens when benchmark rates increase and narrows when benchmark rates decrease, then the empirical duration would be higher than the modified duration. That would be an unusual circumstance, but it’s possible.

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Crystal clear :+1:

Hi @S2000magician, what is the logic behind credit spreads having a tendency to narrow when yields increase? That seems to be the only missing piece in my head.

I suspect that it’s primarily a supply and demand phenomenon: if investors sell Treasuries and buy corporates, then Treasury prices fall (so yields rise) and corporate prices rise (so yields fall, so spreads narrow); if investors sell corporates and buy Treasuries, then Treasury prices rise (so yields fall) and corporate prices fall (so yields rise, so spreads widen).


I dont want to create another post, but to see if I understood correctly. Can someone pls confirm my understanding?

the reason why credit bonds change less in price compared to a benchmark bond, is it because the credit spread and the risk free rate offset each other, hence why the price changes less for a credit bond when there is an increase in the benchmark yields?

I’d have said the change in credit spread offsets the change in the risk-free rate, but you have the idea.

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thank you so much!

My pleasure.