What is the difference between parallel and non-parallel yield curve shifts?

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AcadiFi · Accepted Answer

A parallel shift moves every point on the yield curve by the same number of basis points...

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Historically, parallel shifts explain roughly 60-75% of curve variance, with slope changes (steepening/flattening) adding another 20-25% and curvature (butterfly) changes contributing 5-10%. Principal component analysis on yield changes consistently produces these three factors.

Why it matters: effective duration measures sensitivity to parallel shifts only. A portfolio hedged to effective duration is neutral to a pure parallel shift but fully exposed to non-parallel movements. In practice, non-parallel shifts cause most P&L surprises for duration-hedged portfolios.

Examples: Following a Fed tightening cycle peak, a bull flattener often unfolds — long rates fall more than short rates as growth expectations cool. A duration-neutral long-10y/short-2y portfolio would lose heavily despite zero effective duration. Only KRD or key rate duration analysis captures this risk.

Risk management implication: measure and limit key rate duration contributions, not just total effective duration. For liability-driven investors, match KRDs to liability cash flows at each maturity. For active managers, intentionally take KRD bets aligned with curve views but hedge unintended KRD mismatches. Portfolio attribution separating parallel from slope and curvature P&L helps identify which factors drive returns — a 'duration-neutral' manager who consistently makes money from unintended curve shape bets is taking hidden risk.

What is the difference between parallel and non-parallel yield curve shifts?

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