Bond convexity
Certified Financial Planner glossary · Certified Financial Planner
Definition
Duration is linear; the true price is higher than duration predicts, duration overstates drops when rates rise and understates gains when rates fall.
Bond convexity in plain English
Duration says a yield spike should cut a bond's price by about 6%, but the actual mark falls only 5.4%. Bond convexity is why: duration is a straight-line tangent, while true price lives on a curve above that line. Duration therefore overstates price drops when rates rise and understates rallies when rates fall. Immunization drills also like this cousin fact: a zero-coupon bond's Macaulay duration equals its maturity. All else equal, buyers prefer more convexity in option-free bonds.
Practice Bond convexity
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