Duration and Security Risk

Abstract

Estimation and control of security risk are subjects of major theoretical and practical importance. Much of the literature in this area has focused on the risk associated with returns over a single holding period. Within this context, a great deal of attention has been devoted to estimation of security betas, which relate to coveriance with “the market,” since the well-known Capital Asset Pricing Model implies that expected returns will, in equilibrium, be related to such values. However, a number of papers [3, 7, 14] have considered “extra-market covariances,” i.e., covariances among security returns not due to common correlations with the market as a whole. Accurate estimates of such covariances are necessary for tailoring portfolios to account for differences in investors' circumstances (e.g., tax brackets) and, a fortiori, for active portfolio management designed to exploit any security mispricing.