Spread Duration

Interest rate duration and spread duration are the two primary risk dimensions of a corporate bond position. Interest rate duration measures sensitivity to moves in the risk-free rate level; spread duration measures sensitivity to moves in the credit spread. For a plain vanilla corporate bond without embedded options, these two durations are numerically equal and both equal the bond's modified duration. However, they behave differently in practice and require separate risk management.

Spread duration is particularly important when managing portfolios relative to a benchmark like the Bloomberg US Corporate Bond Index. A portfolio manager who takes a credit overweight — owning more corporate bonds than the benchmark — has higher spread duration than the index. If spreads widen by 50 basis points, the portfolio underperforms the benchmark by approximately (portfolio spread duration minus benchmark spread duration) times 50 basis points.

For floating-rate bonds, spread duration and interest rate duration diverge significantly. A floating-rate note resets its coupon based on a benchmark rate (such as SOFR), so its interest rate duration is very short — close to zero until the next reset. But its spread duration equals its full term to maturity, because the fixed credit spread component compounds over the life of the bond without resetting. This makes floaters useful for credit exposure without significant interest rate risk.

Mortgage-backed securities and callable bonds have spread duration different from their nominal maturity, because the embedded option causes cash flows to respond asymmetrically to spread changes. For these instruments, OAS-based spread duration is the appropriate measure.

In portfolio construction, managing spread duration relative to a benchmark determines how much of the portfolio's return comes from credit exposure versus interest rate exposure. Separating these risks allows more precise positioning based on views on credit conditions versus monetary policy.