Duration essay

The second described application is Duration Gap Analysis which is an extension to the immunization approach, because it includes liabilities. A main function of banks is to provide maturity transformation. Hence, banks usually have short-term liabilities and long-term assets.

In general duration Analysis is an econometric tool and in terms of Financial Economics it is defined as the mean length of time that passes until the present value is returned by a stream of fixed payments according to Macaulay (1938). Hence, Duration is a measure of the sensitivity of asset´s prices to interest movements.

“Portfolio duration” quantifies the Duration of a portfolio of different assets. It is based on the additivity of single durations. Additivity means that the duration of a portfolio is the weighted-average of the durations of the individual securities.

Hence, “empirical duration” was developed to deal with these times. It is calculated by regressing price movements of the asset versus some market benchmark. The next paragraph considers two applications of duration in risk management: Hedging and immunization for a portfolio and Duration Gap Analysis.