Lesson 2 of 5 · 12 min
What drives convexity, and why investors value it
Long maturity, low coupon, low yield and widely spread cash flows all raise convexity, and more convexity means better price behaviour when yields move a lot.
In short
- Convexity moves with the same bond features as duration. All else equal, convexity is higher for a longer maturity, a lower coupon rate and a lower YTM.
- Dispersion of cash flows matters too: of two bonds with the same duration, the one whose payments are more spread out over time has more convexity.
- Convexity is always positive for an option-free fixed-rate bond.
- Of two bonds with equal duration, the more convex one gains more when yields fall and loses less when they rise.
- Because convexity reduces risk, investors pay for it: if the market prices it in, the more convex bond has a higher price and lower yield.
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