medium · FRM Part 1 Valuation and Risk Models
A risk manager is comparing two portfolios, Portfolio A (a bullet strategy) and Portfolio B (a barbell strategy). Both portfolios have an identical effective duration of 6.0 years.
Why might a single effective duration measure fail to predict their relative performance during a yield curve 'twist'?
- The bullet portfolio will always exhibit substantially higher convexity than the barbell strategy, making duration an unreliable predictor here.
- Barbell portfolios are essentially immune to non-parallel yield curve shifts because their cash flow durations are effectively averaged across the entire curve.
- Effective duration technically only applies to zero-coupon bonds, and so it can never validly be used to compare bullet versus barbell coupon-bond strategies at all.
- Effective duration assumes a parallel shift, whereas a twist involves non-uniform changes across maturities where the portfolios have different sensitivities.
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