What Is Adjusted Incremental Duration?
Adjusted incremental duration is an advanced analytical concept in fixed income analytics that quantifies the marginal change in a bond's or bond portfolio's duration, specifically when considering factors that "adjust" the standard duration measure, such as embedded options or non-parallel shifts in the yield curve. Unlike simpler duration metrics, adjusted incremental duration focuses on the change in duration for a small, specific change in underlying market conditions or portfolio composition. It provides a more nuanced understanding of interest rate sensitivity for complex securities or portfolios, allowing investors and portfolio managers to assess how small adjustments affect their overall interest rate risk exposure.
History and Origin
The concept of duration itself was introduced by Frederick Macaulay in 1938, who sought to quantify the sensitivity of bond prices to interest rate fluctuations through his measure, Macaulay duration.8,7 This foundational work laid the groundwork for subsequent duration measures, including modified duration and effective duration, which address various limitations or complexities of bonds. As financial markets evolved and new fixed income instruments with features like embedded options (e.g., callable or putable bonds) emerged, the need for more precise and adaptable duration metrics became apparent. Traditional duration measures, which assume fixed cash flows, proved inadequate for such instruments.6 This led to the development of "adjusted" duration concepts, such as effective duration, which account for how option features can alter a bond's cash flows12345