Duration, used in fixed-income portfolios to measure risk associated with changes in interest rates, is applied here to measure the risk of a stock portfolio. The duration statistic has proved to be a valuable risk indicator for fixed-income portfolios. Duration gives an indication of how sensitive a portfolio is to changes in interest rates. A bond portfolio with a five-year duration would be expected to lose 5% of its value if interest rates rise by one percentage point, or gain 5% if interest rates fall by one percentage point. Dura-tion also provides a benchmark for comparing the relative sensitivity of fixed-income portfolios. A portfolio with a duration of 10 years is twice as volatile as a portfolio with a duration of five years. See sidebar, “Calculating duration,” on how fixed-income duration is computed; Figure 1 illustrates the concept. |
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