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.