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A new measure of spread exposure in credit portfolios.
DTS is a registered service mark of Lehman Brothers.
(ProQuest-CSA LLC: ... denotes formulae omitted.)
Asset allocation in a portfolio or a benchmark is typically expressed in terms of percentage of market value. It is widely recognized that this is not sufficient for fixed-income portfolios, where differences in duration can cause two portfolios with the same allocation of market weights to have extremely different exposures to macro-level risks.
As a result many fixed-income portfolio managers have become accustomed to expressing their allocations in terms of contributions to duration-the product of the percentage of portfolio market value represented by a given market cell and the average duration of securities in that cell. This represents the sensitivity of the portfolio to a parallel shift in yields across all securities within this market cell. For credit portfolios in particular, the corresponding measure would be contributions to spread duration, measuring the sensitivity to a parallel shift in spreads.1
Determining the set of active spread duration contributions to market cells or issuers is one of the primary decisions required of credit portfolio managers. Yet all spread durations are not created equal. Just as one could create a portfolio that matches the benchmark exactly by market weights, but clearly takes more credit risk (e.g., by investing in the longest-duration credits within each cell), one could match the benchmark exactly by spread duration contributions and still take more credit risk-by choosing the securities with the widest spreads within each cell.
These bonds presumably trade wider than their peer groups for a reason-that is, the market consensus has determined that they are more risky-and are often referred to as high-beta because their spreads tend to react more strongly than the rest of the market to a systematic shock. Portfolio managers are well aware of this effect, but many tend to treat it as a secondary effect rather than as an intrinsic part of the allocation process.
To reflect the view that higher-spread credits represent greater exposures to sector-specific risks, we propose a simple risk sensitivity measure that uses spreads as a fundamental element in the credit portfolio management process. We represent sector exposures by contributions to Duration Times Spread (DTS), computed as...