In risk management, what does an increase in duration imply for a bond portfolio?

An increase in duration reflects a higher price sensitivity of a bond portfolio to changes in interest rates. Duration measures the responsiveness of a bond's price to interest rate movements. Specifically, it indicates the weighted average time until a bond’s cash flows are received, which helps assess the bond’s interest rate risk.

When the duration increases, this means that the bond will experience larger price fluctuations in response to changes in interest rates. Essentially, a longer duration indicates that the bond's future cash flows are further away in time, making the present value of those cash flows more sensitive to shifts in discount rates, i.e., interest rates. Consequently, if interest rates rise, the price of the bond will drop more significantly, and if rates fall, the bond’s price will increase more substantially.

This relationship highlights why a bond portfolio with a higher duration will react more dramatically to changes in the interest rate environment, reinforcing the notion that the sensitivity to interest rate changes increases with duration.