Why do we say that Empirical Duration is less than the Modified Duration?
Why do we say this difference is very much pronounced for bonds with higher credit ratings?
Did you check the curriculum?
2020/2021 Level III CFA curriculum, reading 21 (Fixed-Income Active Management: Credit Strategies), §2.3 (Interest Rate Risk), p. 247, second paragraph, first sentence.
We don’t, because it isn’t. It’s more pronounced for bonds with lower credit ratings.
I don’t have the same version.
I can’t figure out the logic of empirical duration being less than modified duration and I also didn’t understand why it is more pronounced for lower credit ratings. Like it is basically implying that modified duration is not a good measure of duration because based on historical data, it seems the real duration is much lower.
I don’t have the 2022 curriculum yet.
Is the credit strategies reading still there? If so, check the reading and section I mentioned.
Yes it is. Empirical duration is lower for lower rated bonds because rates and spreads are inversely related. As rates go up, spreads narrow, more so for lower rated bonds.
So you’ll have a decrease in price but since spreads also narrow your bond will not decrease by as much as predicted by theoretical duration measures. Same with investment grade bonds but much more pronounced with high yield bonds.
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thank you for giving me an answer.
Much appreciated