Key Rate Duration to Measure Curve Risk

Effective duration assumes all rates move in lockstep. They don't. In the 2013 Taper Tantrum, the 10-year yield surged 150 basis points while 2-year rates barely moved (Gurkaynak and Wright, 2013). A portfolio perfectly hedged on effective duration still got crushed if concentrated in the wrong part of the curve. Key rate duration solves this by measuring sensitivity at specific maturity points—2-year, 5-year, 10-year, 30-year—giving you a granular map of where your interest rate risk actually lives.

Why Effective Duration Falls Short (The Parallel Shift Problem)

Effective duration tells you how much your portfolio loses if rates rise 100 basis points. The catch: it assumes every point on the yield curve moves by the same amount, at the same time. This is the parallel shift assumption.

The problem is that yield curves twist, steepen, and flatten constantly. During the 2022-2023 Fed hiking cycle, the 2-year yield rose faster than the 10-year, inverting the curve to nearly -100 basis points at its most extreme (the deepest inversion in decades). A barbell portfolio with heavy exposure to 2-year and 10-year maturities performed very differently than a bullet portfolio concentrated at the 5-year point—even if both had identical effective durations.

The point is: Effective duration is a blunt instrument. It tells you aggregate rate sensitivity but obscures where on the curve that sensitivity concentrates. Key rate duration provides the precision.

What Key Rate Duration Actually Measures

Key rate duration (KRD) measures your portfolio's sensitivity to a 100 basis point change at a single maturity point while holding all other rates constant. Standard key rate points are the 2-year, 5-year, 10-year, and 30-year maturities (though some models use additional points like 3-year, 7-year, or 20-year).

The calculation:

KRD at maturity n = (Price if rate at n falls 1%) - (Price if rate at n rises 1%) / (2 x 0.01 x Initial Price)

Consider a bond priced at $1,000. You shock only the 2-year rate up and down by 100 basis points:

• Price when 2-year rate falls 1%: $1,008
• Price when 2-year rate rises 1%: $992
• 2-year KRD = (1,008 - 992) / (2 x 0.01 x 1,000) = 0.80

This means a 1% increase in the 2-year rate alone causes a 0.80% price decline in this bond.

The durable lesson: The sum of all key rate durations equals effective duration. If your 2-year KRD is 0.80, 5-year KRD is 1.20, 10-year KRD is 2.50, and 30-year KRD is 1.00, your effective duration is 5.50 years. But now you know exactly where that 5.50 years of risk sits on the curve.

Worked Example: Barbell vs. Bullet Under Curve Steepening

You're managing $10 million and comparing two portfolios with identical 5-year effective duration:

Bullet portfolio: 100% in 5-year Treasuries

• 2-year KRD: 0.0
• 5-year KRD: 5.0
• 10-year KRD: 0.0
• 30-year KRD: 0.0

Barbell portfolio: 50% in 2-year, 50% in 10-year Treasuries

• 2-year KRD: 1.0
• 5-year KRD: 0.0
• 10-year KRD: 4.0
• 30-year KRD: 0.0

Scenario: Curve steepens—2-year falls 25 bps, 10-year rises 50 bps

Bullet portfolio impact:

• 5-year rate unchanged (in this simplified scenario): No direct impact

Barbell portfolio impact:

• 2-year position: +1.0 x 0.25% = +0.25% gain
• 10-year position: -4.0 x 0.50% = -2.00% loss
• Net: -1.75% loss

The practical point: Both portfolios have the same effective duration, but the barbell loses 1.75% while the bullet is flat. Key rate duration reveals this exposure before the curve moves.

Using Key Rate Duration for Precise Hedging

Treasury futures at the 2-year, 5-year, 10-year, and 30-year points allow you to hedge specific curve exposures. The DV01 (dollar value of one basis point) for each contract determines your hedge ratio:

Setup: Your portfolio has excessive 10-year KRD exposure of 3.5 years against a benchmark of 2.5 years. Portfolio value is $25 million.

Step 1: Calculate dollar exposure to reduce

Excess 10-year KRD = 3.5 - 2.5 = 1.0 year Dollar duration at 10-year = 1.0 x $25,000,000 x 0.01 = $250,000 per 100 bps DV01 exposure = $250,000 / 100 = $2,500 per basis point

Step 2: Calculate contracts needed

10-year futures DV01 = $850 per $1M notional Contract size = $100,000 face value, so DV01 per contract = $85 Contracts to sell = $2,500 / $85 = 29 contracts (rounded)

The point is: You can surgically reduce 10-year exposure without touching 2-year or 30-year risk. This is impossible with effective duration alone.

Key Rate Duration in Liability-Driven Investing

For pension funds and insurers matching assets to liabilities, key rate duration matching is superior to simple duration matching (CFA Institute, 2026). The reason: liabilities often have specific payout schedules that create concentrated exposures at certain maturities.

Consider a pension liability with major payouts at years 10 and 20. The liability's key rate profile might show:

• 10-year KRD: 4.2
• 20-year KRD: 6.8
• All other points: minimal

Matching only effective duration (say, 8 years) with a laddered bond portfolio spreads your asset sensitivity across the entire curve. If 10-year and 20-year rates rise while shorter rates fall, your assets could gain while your liability value rises even more—creating a funding gap.

The durable lesson: Key rate duration matching aligns asset and liability sensitivity at each curve point, immunizing against any curve shape change (not just parallel shifts).

Detection Signals: Your Curve Risk May Be Misunderstood If...

• You describe portfolio duration as a single number without knowing the key rate breakdown
• You hedge a barbell portfolio with a single duration overlay (assuming parallel shifts)
• Your liability-matching strategy uses only aggregate duration and convexity
• You've been surprised by losses during curve steepening or flattening despite "hedged" duration
• You can't explain why two portfolios with identical durations performed differently in the same rate environment

Common Mistakes in Key Rate Analysis

Mistake 1: Ignoring intermediate maturities

Standard 2, 5, 10, 30-year points miss exposures at 3-year, 7-year, or 20-year. If your portfolio concentrates at 7 years, the interpolation between 5-year and 10-year KRD may not capture your actual risk.

Mistake 2: Treating key rates as independent

In reality, a 50 bps move at the 10-year often comes with some movement at the 5-year and 30-year. Stress testing should include realistic curve shift scenarios (steepeners, flatteners, twists), not just single-point shocks.

Mistake 3: Static analysis without rebalancing

Key rate exposures drift as time passes and rates change. A bond that was a 10-year exposure becomes a 9-year, then 8-year. Periodic recalculation is essential (typically quarterly for institutional portfolios).

Key Rate Duration Checklist

Essential (high ROI)

• Know your key rate exposures at 2y, 5y, 10y, 30y points (not just aggregate duration)
• Verify key rate durations sum to effective duration (sanity check)
• Match liability key rate profile if immunizing (not just total duration)

High-impact (workflow integration)

• Stress test for steepening, flattening, and parallel shifts separately
• Use maturity-matched futures to hedge specific curve points
• Recalculate key rate exposures quarterly or after major rate moves

Your Next Step

Pull your portfolio's holdings and calculate (or request from your custodian) the key rate duration breakdown at 2, 5, 10, and 30-year points. Sum them to verify they equal your stated effective duration. Then ask: if the 2-10 spread widens by 50 basis points (10-year up, 2-year flat), what happens to my portfolio value? If you can't answer precisely, you're carrying curve risk you haven't measured.

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Related: Interpreting Steepeners and Flatteners | Barbell vs. Bullet Strategies Under Curve Shifts | Using Futures and Swaps to Adjust Duration | Stress Testing Portfolios for Rate Shocks