Since investors demand a risk premium to hold securities other than risk-free (i.e.
free of credit risk, liquidity risk, prepayment model risk, etc.) debt, and that risk
premium is not constant over time, spread duration is an important measure to
include in the risk management process. Spreads can change in response to beliefs
about the general health of the domestic economy, to forecasts about particular
sectors (e.g. if interest rates rise, spreads in the finance sector may increase due to
concerns about the profitability of the banking industry), to political events (particularly
in emerging markets) that affect liquidity, and so on. Often, investors are just
as concerned with the magnitude and direction of changes in spreads as with changes
in interest rates, and spread duration allows the risk manager to quantify the
impact of changes in option-adjusted sector spreads across a variety of fixed-income
investment alternatives.
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