Total Portfolio Duration: A New Perspective on Asset Allocation

Abstract

The concept of duration has proved to be a valuable tool for gauging the sensitivity of a bond portfolio to movements in interest rates. By balancing the duration of a fixed-income portfolio against the duration of the stream of liabilities it is funding, one creates a portfolio that is immunized against interest rate changes. But what if the portfolio contains stocks as well as bonds? The interest rate risk of an equity portfolio can be estimated from a measure of the correlation between stock and bonds by using variance parameters routinely used in conventional asset allocation procedures. The correlation is used in conjunction with a measure of bond market duration to derive an estimate of the duration of the stock market. These durations, together with a portfolio's allocations to stocks and bonds and the beta of the stock component, may be used to obtain a measure of total portfolio duration. What the duration measure tells us, in general, is that a total portfolio's sensitivity to interest rate mo...

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