Modified Duration

Definition of Modified Duration

Modified Duration is a measure of the sensitivity of a Fixed-Income Security‘s price to changes in interest rates. It is calculated as the weighted average of the time to each of the security’s cashflows, with the weights being the present values of each cashflow divided by the security’s current price. Modified Duration is typically expressed in years.

Role in Financial Markets

Modified Duration is an important concept in modern financial markets, particularly in the bond and fixed-income markets. It is used by investors to assess the Risk of a security and to make Investment decisions. Modified Duration can also be used by portfolio managers to construct portfolios with a desired risk profile.

Economic Impact

Modified Duration has a significant impact on economic policies, financial stability, and market behavior. For example, when interest rates increase, the prices of fixed-income securities with longer Modified Durations tend to decline more than those with shorter Modified Durations. This can have a negative impact on the economy by reducing the Value of retirement savings and pension funds.

Regulatory Aspects

Modified Duration is regulated in many countries, including the United States and the European Union. The purpose of these regulations is to protect investors by ensuring that they have sufficient information about the risks associated with fixed-income securities. In the United States, Modified Duration is regulated by the Securities and Exchange Commission (SEC).

Historical Development

The concept of Modified Duration was first developed in the 1960s by Frederick Macaulay. Macaulay’s original measure was called “Duration,” but it has since been modified to take into account the effects of reinvestment. Modified Duration is now the standard measure of interest rate sensitivity for fixed-income securities.