Negative Convexity
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Definition of 'Negative Convexity'When the shape of a bond's yield curve is concave. A bond's convexity is the rate of change of its duration, and is measured as the second derivative of price with respect to yield.Most mortgage bonds are negatively convex. |
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Investopedia explains 'Negative Convexity'Callable bonds are negatively convex at lower yields than the yield at which the bond is likely to be called.One property of a non-callable bond is that as interest rates fall, its price will increase. However, with a callable bond, as interest rates fall, the incentive for the issuer to call the bond at par increases; therefore, its price will not rise as quickly as the price of a non-callable bond. The price of a callable bond might actually drop as the likelihood that the bond will be called increases. This is why the shape of a callable bond's curve of price with respect to yield is concave or "negatively convex." |
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