Definitions for "Effective Duration"
(1) One of several methods of expressing duration. More accurate than Macaulay duration or modified duration. See convexity, duration, Macaulay duration, and modified duration(2) A synonym for empirical duration. See empirical duration.(3) A synonym for option-adjusted duration. See option-adjusted duration.
The duration for a bond with an embedded option when the value is calculated to include the expected change in cash flow caused by changes in interest rates. This measures the responsiveness of a bond's price to interest rate changes.
In text-book terms this is the same as modified duration. However, it is now more commonly used to describe a portfolio's duration relative to a benchmark. For example, a portfolio with an effective duration of 120% is 20% overweight duration compared to the chosen benchmark meaning that it is taking on more risk .