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YouTube T4-37: Fixed income: Effective Convexity

Nicole Seaman

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Effective convexity approximates modified convexity (just as effective duration approximates modified duration). Mathematically, convexity is a function of the bond's second derivative with respect to yield: convexity = 1/P*∂^2P/∂y^2. Convexity is illustrated by the curvature (i.e., non-linear) nature of the bond's price/yield relationship.
The formula for effective convexity is given by: C = 1/P * [P(+Δy) + P(-Δy) - 2*P]/(Δy)^2


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