What is Negative Convexity?
Negative convexity prevails when the form of a bond’s generate bend is concave.
A bond’s convexity is the rate of change of its length, and it is calculated as the second mixture of the bond’s cost with regard to it’s generate. Most mortgage ties are negatively convex, and callable ties usually display negative convexity at lower results in.
Typically, when prices appealing reduce, a bond’s cost improves. For ties that have negative convexity, prices reduce as prices appealing fall. For example, with a callable Correlation, as prices appealing fall, the motivation for the company to call the Correlation at par increases; therefore, its cost will not increase as quickly as the cost of a non-callable Correlation. The cost of a callable Correlation might actually fall as the possibility that the Correlation will be called improves. This is why the form of a callable bond’s bend of cost with regard to generate is concave or negatively convex. Most home loan ties are adversely convex, mostly because they can be pre-paid. Callable ties can also display adverse convexity at certain costs and results in.