Convexity effect

[librosdeholanda]

Good morning,

Could you please help me understand the effect of convexity based on the shape of the curve? I have been struggling with this concept for a while and I would like to understand some examples. That way I could finally get when the convexity term in the Taylor term approximation needs to be added or substracted to achieve the outcome we are looking for (eg, calculating VaR for an option). Ideally, I imagine you could use graphic examples to make it more clear.

Thanks.

 

[David Harper CFA FRM]

Hi @librosdeholanda We already have dozens (hundreds?) of convexity discussions and illustrations, here is a tag https://forum.bionicturtle.com/tags/convexity/ (you can also search related tags here https://forum.bionicturtle.com/tags/ e.g., we have tags for analytical-convexity, effective-convexity, modified-convexity, and negative-convexity).

But maybe the best is the series of videos that I did where I really focused on convexity fundamentals (with illustrations). This is found at https://forum.bionicturtle.com/forums/p1-t4-valuation-risk-models.104/ My fixed income series starts way back at T4-21 with DV01/duration concepts starting at T4-32 and then convexity starts at T4-37 , specifically:

• T4-37: Fixed income: Effective Convexity https://forum.bionicturtle.com/threads/t4-37-fixed-income-effective-convexity.22527/
• T4-38: Fixed Income: Duration plus convexity to approximate bond price change https://forum.bionicturtle.com/thre...exity-to-approximate-bond-price-change.22718/
• T4-39: Fixed Income: Impact of Yield and Coupon on Duration and DV01 https://forum.bionicturtle.com/thre...-yield-and-coupon-on-duration-and-dv01.22719/
• T4-40: Fixed Income: Bullet versus Barbell Bond Portfolio https://forum.bionicturtle.com/thre...e-bullet-versus-barbell-bond-portfolio.22742/
• T4-41: Fixed Income: Analytical Convexity; aka, modified convexity https://forum.bionicturtle.com/thre...tical-convexity-aka-modified-convexity.22765/
• T4-42: Fixed Income: Duration and Convexity Summary https://forum.bionicturtle.com/threads/t4-42-fixed-income-duration-and-convexity-summary.22766/

Re Taylor Series, it also has a tag and this video may be useful: https://forum.bionicturtle.com/thre...r-with-the-taylor-series-approximation.22463/ I hope that's helpful,