Interest rate risk is the risk (variability in value) borne by an interest-bearing asset, such as a loan or a
bond, due to variability of
interest rates. In general, as rates rise, the price of a
fixed rate bond will fall, and vice versa. Interest rate risk is commonly measured by the bond's
duration.
Interest rate risk analysis is almost always based on simulating movements in one or more yield curves using the Heath-Jarrow-Morton framework to ensure that the yield curve movements are both consistent with current market yield curves and such that no riskless arbitrage is possible. The Heath-Jarrow-Morton framework was developed in the early 1990s by David Heath of Cornell University, Andrew Morton of Lehman Brothers, and Robert A. Jarrow of Kamakura Corporation and Cornell University.
There are a number of standard calculations for measuring the impact of changing interest rates on a portfolio consisting of various assets and liabilities. The most common techniques include
Banks face four types of interest rate risk