Duration gap measures the difference between the interest-rate sensitivity of assets and the liability-funded portion of those assets.
Duration gap measures the difference between the interest-rate sensitivity of assets and the liability-funded portion of those assets. Banks and other asset-liability managers use it as a simplified estimate of how a rate change could affect the economic value of equity.
A positive duration gap generally means asset value is more sensitive than liability value to a parallel rate increase, so economic value of equity would tend to fall. A negative duration gap generally indicates the opposite direction under the same assumptions.
Using modified duration:
where:
The leverage adjustment (L/A) reflects that liabilities fund only part of the asset base. Equity funds the remainder.
For a small parallel change in rates:
where (\Delta EVE) is the approximate change in economic value of equity and (\Delta y) is the rate change in decimal form.
If Macaulay rather than modified duration is used, the conversion to price sensitivity requires an additional yield adjustment. Analysts should state the duration convention.
Assume a bank has:
$100 million$90 million4.52.0First calculate the duration gap:
For a parallel rate increase of one percentage point:
The simplified estimate indicates a $2.7 million decline in economic value of equity.
This is not a forecast or exact valuation. It assumes small and parallel rate changes, stable cash flows, accurate duration estimates, and no important nonlinear options.
| Duration gap | Simplified effect of rising rates | Simplified effect of falling rates |
|---|---|---|
| Positive | Asset value falls more than liability value | Asset value rises more than liability value |
| Near zero | First-order value changes are approximately matched | First-order value changes are approximately matched |
| Negative | Liability value falls more than asset value | Liability value rises more than asset value |
A near-zero aggregate gap can still hide risk. Exposures at different yield-curve maturities can offset under one parallel scenario but produce losses when the curve twists. Different benchmark rates can also diverge.
| Measure | Primary focus | Typical horizon | Main limitation |
|---|---|---|---|
| Duration gap | Present-value sensitivity of assets and liabilities | Economic life of cash flows | Depends on valuation and duration assumptions |
| Repricing gap | Amounts resetting or maturing within time buckets | Often near-term earnings horizon | Does not measure full economic-value sensitivity |
A repricing gap may indicate how rate changes affect net interest income over a stated period. Duration gap indicates how present values respond. A bank can appear balanced under one measure and exposed under the other.
See Interest-Rate Risk for repricing, yield-curve, basis, and option risk.
A defensible duration-gap calculation requires:
Nonmaturity deposits are especially assumption-sensitive because they have no contractual maturity that directly describes customer behavior. Loans can prepay, commitments can be drawn, and deposit balances can migrate when rates change.
A single duration gap is most useful for a small parallel yield-curve move. It can miss steepening, flattening, and localized maturity shocks. Key-rate duration or full revaluation can provide more detail.
Duration is a first-order measure. Convexity and embedded options matter for large moves and nonlinear instruments.
Assets, liabilities, and hedges may reference different rates. Similar durations do not ensure that those benchmarks move together.
Deposit stability, loan prepayment, early withdrawal, and product renewal can change with rates. Modeled durations can therefore differ materially from contractual cash-flow timing.
Duration gap measures economic-value sensitivity. It does not replace net-interest-income simulations, margin analysis, or liquidity stress testing.
Offsetting positions across currencies, entities, or legal restrictions may not be economically interchangeable.
Duration gap can support:
Possible responses include changing asset or liability duration, adjusting the fixed-floating mix, using derivatives, altering funding terms, or accepting the exposure within an approved limit. Each response introduces cost and potentially other risks.
Regulatory scenarios, disclosure requirements, and acceptable model assumptions vary by institution and jurisdiction. Verify the current applicable framework.
This article is for financial education only. It does not evaluate a specific institution, balance sheet, capital level, or hedge and is not personalized investment, accounting, legal, regulatory, or risk-management advice.