Forums  > Pricing & Modelling  > Parallel Interest Rate Shocks (shock before boot strapping or after?)  
     
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JohnCheng


Total Posts: 1
Joined: Oct 2021
 
Posted: 2021-10-25 18:52
I'm looking to create interest rate shocks (parallel (25/50/75 bps up/down), non parallel (steepener/flattener) on a fixed income portfolio. Should I be shocking the market instruments before bootstrapping or shocking the zero curve after bootstrapping? This would apply to both swap curves (eg. USD 3M LIBOR) as well as government (eg. US treasury).

I think the answer is to shock the zero curve after bootstrapping - but i'm not sure why. Thanks!

silverside


Total Posts: 1448
Joined: Jun 2004
 
Posted: 2021-11-01 11:31
(a sensible question for once rather than spam, thank you!)

I was always trained to apply shocks to the market calibration instruments (i.e. swap rates) as this provides the hedge deltas immediately - in other words (using your example) you know you have to buy 25bps dv01 on the 2y, 50bps on the 5y, etc. Whereas if you stress the zero curve, the hedge portfolio (using standard market instruments) will be more messy.
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