South African Journal of Economic and Management Sciences
On-line version ISSN 1015-8812
Most contemporary bonds have embedded options and all face the possibility of default. Both features introduce risk (the former market risk and the latter credit risk) by altering the quantity and timing of the promised cash flows. The Macaulay duration, although a popular risk tool, is increasingly unable to cope in this complex financial environment. While the Macaulay duration has undergone modifications before, a new theoretical framework is now introduced which augments its functionality while retaining its tractability. The approach - though still unable to isolate the effects of the two features - yields consistent results which agree well with empirical data.