Duration, modified duration, and convexity are traditional methods of managing interest rate risk. These traditional concepts assume the parallel shift of the yield curve, but in the environments characterized by volatile interest rates there are nonparallel yield curve shifts beyond the assumption of traditional duration measure and management. For analyzing and hedging yield curve risk in the Korean bond market, this thesis uses principal component models and key rate durations.
This thesis shows that the Korean Treasury bond market is characterized by two or three factors based on the principal component analysis. Also factor immunization strategies and key rate duration hedges are tested in the KTB market. When using KTBs for interest rate risk hedge based on key rate duration, a careful selection is needed for on-the-run issues because of the premium over the implied price from the yield curve.
