Duration measures a bond's price sensitivity to interest rate changes, expressed in years. A bond with a duration of 7 will lose roughly 7% of its value if rates rise by 1 percentage point, and gain roughly 7% if rates fall by the same amount.
Why It Matters
Duration is the single most important risk number in fixed-income portfolio management — it's how bond desks and insurers match asset durations to liability durations (asset-liability management), and it's the first thing an allocator asks about a bond fund before checking yield. Getting duration wrong is how portfolios take unexpected losses in rising-rate environments.
How It Works in Practice
- 1Modified duration approximates the percentage price change for a 1% change in yield
- 2Longer maturities and lower coupons both increase duration — zero-coupon bonds have the highest duration for a given maturity
- 3Portfolio duration is the weighted average of the durations of its individual holdings
- 4Convexity refines the estimate for larger rate moves, since the price/yield relationship isn't perfectly linear
Common Pitfalls
Modified duration is a linear approximation — it understates gains and overstates losses for large rate moves, which is exactly where convexity matters most
Callable and mortgage-backed bonds have effective duration that changes as rates move (negative convexity), making standard duration math misleading
Matching duration alone doesn't hedge against yield curve twists — a portfolio can be duration-matched to a liability and still lose money if short and long rates move differently