MEASURING THE INTEREST RATE RISK

This paper develops the theory of the measurement of interest rate risks from its foundations, beginning with the question of which asset values (market or book) are economically relevant and therefore at risk. Upon this foundation, the paper builds a flexible and general theory of the measurement of interest rate risk that includes the familiar Macaulay-Redington theory as one special case. The theory is applied using a simple model of interest rates to allow separate measurement of the risks associated with permanent and transient changes in interest rates.