How is the empirical duration of a corporate bond estimated?

Question

What will be an ideal response?

Answer 1

Empirical duration is computed statistically using historical market-based bond prices and historical market-based Treasury yields. When the historical yields change, the historical bond prices will be modified accordingly.Regression analysis is the statistical method used to calculate empirical duration. More details are below.

To empirically estimate the sensitivity of a high-yield bond to changes in interest rates, we use the technique of regression analysis. The estimated modified duration obtained from the regression is referred to as empirical duration. For any high-yield corporate bond, a simple regression of its price change versus the Treasury yield change over the past 30 days (or 60 or 90) will give a bond-specific estimate of empirical duration. Like any such numerical methods, direct calculation of empirical durations can be very sensitive to irregularities in the pricing data. One could calculate these for many bonds over many periods of time, and then compare results with estimates based on bond characteristics such as spread or credit ratings.

One study investigated, using regression analysis, the interest-rate sensitivity of corporate bonds of different credit ratings. Daily data for the period August 1998 to November 2009 for six credit rating categories of the Barclays Capital Corporate Investment Grade and High Yield Indices (Aaa/Aa, A, Baa, Ba, B, and Caa) were used. The first three credit rating categories (Aaa/Aa, A, and Baa) are investment-grade credit rating categories. The last three credit rating categories (Ba, B, and Caa) are high-yield credit rating categories. For the change in Treasury yields, the 10-year yield is used. The regression results indicated that for lower-rated corporate bonds, the bond's price movement was less sensitive to the change in the level of interest rates (as measured by the 10-year Treasury rate).