Equity Duration

This chapter explores the concept of equity duration, tracing its origins back to the pioneering work of Macaulay and subsequent contributions by Hicks, Samuelson, and others. The text delves into the challenges of extending the concept of duration from bonds to equities, highlighting the unique characteristics of equity cash flows and the impact of changes in discount rates. The chapter presents three main methodological approaches to measuring equity duration: theoretical, statistical, and hybrid. The theoretical approach is based on the dividend discount model (DDM) and provides a forward-looking measure of equity duration. The statistical approach uses time series data to estimate the sensitivity of stock prices to changes in interest rates, providing a backward-looking measure. The hybrid approach combines balance sheet data and market information to estimate equity duration. The chapter also discusses the equity duration paradox, which refers to the discrepancy between the high duration estimates obtained using the theoretical approach and the lower estimates obtained using the statistical approach. The text explores various explanations for this paradox, including the impact of changes in expected inflation and real interest rates on equity duration. The chapter concludes by highlighting the importance of a correct measurement of equity duration for financial immunization, risk management, asset allocation, and the estimation of the opportunity cost of equity capital.