Duration analysis measures the average life of a financial instrument and how sensitive it is to interest rate changes. It involves comparing the duration of individual assets and liabilities, with duration defined as a weighted average lifetime that gives a direct measure of interest rate sensitivity. A bank's duration gap is determined by taking the difference between the duration of its assets and liabilities, using weighted averages of the durations. While duration gap analysis helps assess interest rate risk, it has limitations including difficulty finding assets and liabilities of exactly the same duration and uncertainty around cash flows from some accounts.

1. DURATION ANALYSIS
Duration analysis is defined as the average life of a financial instrument .
Duration gap directly indicates the effect of interest rate changes on the net worth
of the institution. The application of duration analysis requires extensive data on
the specific characteristics and current market pricing schedules of financial
instrument . Duration analysis it is an approach for measuring of percentage of
change in economic value of a position that will occur given a small change in the
level of interest rates.
Duration analysis start by comparing the individual duration of each assets and
liability .
Duration is a scientific concept used for assessing the weighted average life time
of instrument
The concept is constructed in such a way that it gives a direct measure of interest
rate sensitivity; the longer the duration, the higher the sensitivity to interest rate
changes.
Duration Analysis is a method for risk management with a focus on strategies for
immunization.
Duration as a method to estimate how a change in interest rate had influence on
the value of a financial instrument.

2. Determination of the duration gap
A banks duration gap is determined by taking the difference between the
duration of a banks assets and the duration of its liabilities. The duration of the
banks assets can be determined by taking a weighted average of the duration of
all of the assets in the banks portfolio.
The weight is the dollar amount of a particular type of asset out of the total
dollar amount of the assets of the bank. The duration of the liabilities can be
determines in a similar manner.
The concept of duration helps in immunizing the interest rate risk by holding
and investment till the end of duration, instead of maturity. Having determined
the duration, the affect of rate fluctuation on the NIM and the marker value of
the assets/liabilities of a bank can be assessed further by computing the
duration gap for the portfolio of its assets and liabilities.
The method followed to monitor the impact of rate fluctuation on NIM using
duration is similar to the one used in maturity gap approach. However, the rate
sensitive gap calculated in duration and not the maturity of the assets and
liabilities.

3. Limitation of duration gap analysis
there are several limitation with duration gap analysis
1. It is difficult to find assets and liabilities of the same duration to fit into the banks
portfolio.
2. in addition some account such as deposits and others dont have well defined
patterns of cash flows which makes it difficult to calculate duration for these
account .
3. duration is also affected by prepayment by customers as well as default.