Duration Is the Number That Explains Every Bond Loss
A bond's price sensitivity to interest rates is not intuition, it is a calculation. Duration converts a rate change into a price change and explains most of what went wrong in 2022 and 2023.
The Core Relationship
Bond prices move opposite to yields. That much most people know. Duration answers the follow up question, which is by how much.
Modified duration approximates the percentage change in a bond's price for a one percentage point change in yield. A bond with a duration of seven falls roughly 7 percent when yields rise one point, and rises roughly 7 percent when yields fall one point.
That single number turns an abstract worry about rates into a specific expected loss, which is why every fixed income desk manages it explicitly.
What Drives Duration
Three factors determine it. Longer maturity increases duration, because more payments sit further in the future and are discounted more heavily. Lower coupons increase duration, because less of the total return arrives early. And lower yields increase duration, which is why rate risk was unusually high after years of near zero rates.
That last point deserves emphasis. When yields are very low, bonds are more sensitive to rate changes than usual. Portfolios built during the zero rate era carried more duration risk per dollar than the same portfolios would have carried in a normal rate environment, and many holders did not appreciate that.
A thirty year Treasury with a duration near seventeen loses roughly seventeen percent of its value when yields rise one point. Government backing guarantees payment, not price.
The 2022 and 2023 Application
This is the arithmetic behind the losses. When the Federal Reserve raised rates by more than five percentage points across the cycle, long duration bonds fell severely. That was not a credit event and no issuer failed to pay. It was duration doing exactly what duration does.
Banks holding long dated securities purchased at low yields carried enormous unrealized losses for the same reason. The securities would pay in full at maturity. Their market value in the meantime was far below cost, and that gap mattered the moment anyone had to sell.
Convexity, Briefly
Duration is a linear approximation and the true relationship curves. Convexity measures that curvature.
For ordinary bonds convexity is positive, which is favorable to the holder. Prices rise slightly more when yields fall than they fall when yields rise by the same amount. For small moves duration alone is adequate. For large moves, the ones that matter, ignoring convexity understates gains and overstates losses.
Mortgage backed securities behave differently and can exhibit negative convexity, because homeowners refinance when rates fall, which shortens the security exactly when the holder would prefer it lengthen. That asymmetry is why mortgage portfolios require specialist management.
How to Use It
The practical application is matching duration to horizon. An investor who needs money in three years should not hold a portfolio with a duration of fifteen, because a rate move could impose a loss with no time to recover.
Pension funds and insurers formalize this as liability driven investing, matching the duration of assets to the duration of promised payments so that rate moves affect both sides equally. The 2022 gilt crisis in the United Kingdom happened when the leveraged version of that strategy met a rate move faster than the collateral could be posted.
The Bottom Line
Duration converts a rate forecast into an expected price change, and it explains nearly every bond loss of the last few years. A safe bond and a stable price are not the same thing.