can someone plz explain why holding a payer swaption will shorten the duration of a portfolio and holding a receiver swaption will lengthen the duration. thx.
Payer swaption gives you a right to enter into payer swap. Payer swaption per se won’t affect portfolio duration, payer swap will. Payer swap = pay fixed, receive floating = - fixed + floating Paying fixed reduces the duration and receiving floating increases duration, since fixed has higher duration than floating the net affect is reduction. For instance duration of one-year fixed bond with quarterly payments would probably be between 0.6 and 1.0 (depending on the characteristics of the bond); duration of a floating bond with quartrly payments would be approximatelly 1/frequency of coupon payments divided by 2 or (1/4)/2 = 0.125 So usinng this one-year bond as an example, by paying fixed you would decrease duration by 0.6 (on the low side) and by receiving floating increase it by 0.125, net effect is 0.475 reduction in duration. For receiver swap (or receiver swaption by extension) reverse applies.
as volkov states…swaption is an OPTION to increase/decrease portfolio duration
thanks!