Contraction Risk

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Contraction Risk

The risk that the duration of a debt security will decline because of prepayment. Duration is the length of time it takes to receive the present value of future principal and interest payments on a debt security; prepayment will deprive the holder of a bond of future coupons, resulting in less interest and therefore a shorter duration. Contraction risk is most prominent in mortgage-backed securities. See also: Prepayment risk.