How Convexity Affects the Choice of a Bond to Short

Summary

The note considers which bond to short when two bonds are otherwise comparable. For a purely speculative position, the answer favors the bond with lower convexity. Convexity describes how a bond’s price sensitivity changes as yields move, so it affects the shape of the price response beyond duration alone.

The answer also cautions that convexity is reflected in market prices. A bond with lower convexity than another bond of equal duration would generally trade cheaper, so the theoretical preference does not by itself establish an attractive trade. The note gives no calculations or empirical comparison, and its conclusion is limited to the stated all-else-equal, speculative setup.

Key ideas

• For a speculative short with other characteristics held equal, the answer favors the bond with lower convexity.
• Convexity differences are priced by the market, so equal-duration bonds may differ in price.
• A lower-convexity bond may be cheaper, which can offset the apparent preference for shorting it.

Tags

# Short bond convexity


# Short bond convexity












Assuming you need to pick a bond to short. Is it better a bond with large or small convexity (all other things being equal)?

## Answer by user68819 (score 1, accepted)

https://quant.stackexchange.com/a/79973

If this is purely speculative and all else the same you would choose to sell the bond with the least convexity.

But, convexity is priced by the market, so in reality a bond with lower convexity relative to a higher convexity bond (or portfolio) of equal duration would also trade cheaper (usually).

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.