Spread Duration

A measure of a bond’s (or portfolio’s) credit spread risk, i.e.
its sensitivity to a change in the premium over risk-free Treasury rates demanded
by investors in a particular segment of the market, where the premium is
expressed in terms of an option-adjusted spread (OAS). The impact of a change
in spreads is an important source of risk for all dollar-denominated fixed-income
securities other than US Treasuries, and will become increasingly important in
European debt markets if the corporate bond market grows as anticipated as a
result of EMU. To calculate spread duration, a bond’s OAS (as implied by its
current price) is increased and decreased by a specified amount; two new prices
are computed based on these new OASs, holding the current term structure of
interest rates and volatilities constant. The bond’s spread duration is the average
percentage change in its price, relative to its current price, given the higher and
lower OASs (scaled to a 100 bp shift in OAS).
Spread duration allows risk managers to quantify and differentiate a portfolio’s
sensitivity to changes in the risk premia demanded across market segments such
as investment grade and high yield corporates, commercial mortgage-backed and
asset-backed securities and so on.