The Limitations of Standard Deviation as a Measure of Bond Portfolio Risk

Abstract

The standard deviation of investment returns is widely accepted as the best, and perhaps only commonly used indicator of portfolio risk in the investment management business. However, its usefulness is actually quite limited. In fact, relying on it can often produce misleading and inaccurate conclusions, particularly when applied to fixed-income portfolios. Though he demonstrates a number of flaws associated with relying on the standard deviation of returns as a risk measure, the author states that standard deviation does provide some insight, and in many circumstances is in fact meaningful. As always, the key is to understand what goes on behind the numbers.