Editing Duration gap (section)

==Management==
{{also|Financial risk management#Banking}}
As outlined, a key objective of ALM is to measure and then manage the direction and extent of any asset-liability mismatch - i.e. a funding or "maturity gap" - so as to maintain adequate profitability. <ref name="analystprep"/><ref name="Mishkin"/>
This exercise will have the joint objectives of balancing maturities, cash-flows and / or interest rates, for a particular time horizon. The management thus takes the form of:
*matching the maturities of loans and investments with the maturities of deposits, equity, and external credit; the techniques commonly employed are [[Immunization (finance)|immunization]] and [[cashflow matching]].
*managing the spread between interest rate sensitive assets and interest rate sensitive liabilities; see {{slink|Corporate bond#Risk_analysis}} and {{slink|Yield spread#Yield spread analysis}}.

A formula sometimes applied is:
<math>Duration \ gap = duration \ of \ earning \ assets \ - \ duration \ of \ paying \ liabilities \ \times \ \frac{paying \ liabilities}{earning \ assets}</math>

Implied here, is that even if the duration gap is zero, the firm is immunized only if the size of the liabilities equals the size of the assets. Thus as an example, with a two-year loan of one million and a one-year asset of two millions, the firm is still exposed to [[Deposit_risk#Types_of_deposit_risk|rollover risk]] after one year when the remaining year of the two-year loan has to be financed.

<math>0 = 1 - 2 \times \frac{1,000,000}{2,000,000}</math>

Further limitations of the duration gap approach to risk-management include the following:
* the difficulty in finding assets and liabilities of the same duration
* some assets and liabilities may have patterns of cash flows that are [[Embedded option|not well defined]]
* [[Prepayment of loan|customer prepayments]] may distort the expected cash flows in duration
* [[default (finance)|customer defaults]] may distort the expected cash flows in duration
* [[bond convexity|convexity]], the extent to which duration is non-linear, can cause problems in estimation.