Key points
- Positive convexity benefits bondholders.
- Mortgage-backed securities have negative convexity.
- Important for large rate moves.
Example
A 30-year bond yielding 5% gains about 17% if yields fall 1 percentage point, but loses only about 14% if they rise by the same amount. That asymmetry is positive convexity.
In history
In 2022, as mortgage rates rose, homeowners stopped refinancing, so mortgage-backed securities paid back more slowly than expected. Their duration lengthened just as prices fell, a form of negative convexity known as extension risk.
Related terms