In part 1e, we review how the VaR measure is calculated for Fixed Income bonds using the Rate VaR approach and the Full Valuation Price VaR approach and the difference between the results of these two approaches. We see how a Delta Normal approximation applied to the Rate VaR approach improves on the results as it adjusts the measure for the specific characteristics of the bond (i.e. maturity, yield, interest rate sensitivity, etc). We discuss how this approximation can be further improved by considering the convexity adjustment. Finally we illustrate the difference between Rate VaR and Price VaR by looking at the histograms of daily rate and price returns respectively.
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