Comparing Parallel and Key Rate Shocks for Floor Option EVE

Summary

The document poses a risk measurement question about a portfolio of plain interest rate floor options. It asks whether the change in economic value under a one basis point parallel rate shock should equal the sum of value changes under one basis point shocks to individual key rates. The measure is framed as EVE risk, or a present-value sensitivity to interest rate changes.

No answer, calculation, or market evidence is included, so the document does not establish whether the two measurements should agree. The comparison depends on how the key rate shocks are defined and combined, as well as on the valuation model and the portfolio’s sensitivity to changes across the curve. The text serves as a prompt for examining rate risk decomposition rather than a complete method for calculating or interpreting floor option exposure.

Key ideas

• The question concerns economic value sensitivity for a portfolio of interest rate floor options.
• It compares a parallel rate shock with separate shocks to key rates.
• The proposed comparison is between the parallel shock risk and the sum of key rate shock risks.
• The document provides no derivation or conclusion about when the measures are equal.

Tags

# Floor option EVE risk: Sum of key rate shocks risks vs. the rates parallel shock risk


# Floor option EVE risk: Sum of key rate shocks risks vs. the rates parallel shock risk












Consider a model measuring the EVE risk (change in the economic value by shocking the rates; PV01) of a portfolio of vanilla interest rate floor options. Is there any reason for the EVE risk of a floor option under 1bp parallel shock of the rates being equal to the sum of EVE risks resulting from the 1bp shock of the key rates?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.