Duration Forty Years Later

The risk inherent in the price fluctuations of bonds has many dimensions. These include default risk, inflation risk, and call risk. The most important single source of risk, particularly for government and high-grade corporate bonds, is basis-risk price fluctuations caused by shifts in interest rates. For a given shift in the yield curve, and holding other factors unchanged, longer term-to-maturity bonds generally suffer greater price changes than shorter maturity bonds. This characterization is not exact because high coupon bonds are less volatile than low coupon bonds. Intuition says that this is to be expected because, other things being equal, high coupon bonds have a greater percentage of their value due to the interim coupons and, hence, have a shorter “effective” maturity. Duration may be interpreted as an attempt to quantify this qualitative statement through the use of a single, numerical measure intended to be used in place of maturity.