Why Rate Volatility Can Raise Vasicek Bond Prices

Summary

The document asks why a bond price in the Vasicek interest-rate model rises as rate volatility increases. Its answer attributes the effect to convexity: a bond’s value is a convex function of interest rates, so taking an expectation over a more dispersed rate distribution can raise the expected bond value.

The explanation invokes the general relationship between convex payoffs and dispersion, rather than a special feature of Vasicek dynamics. It therefore frames the intuition as model independent. The source provides no derivation, numerical example, or detailed statement of the assumptions needed for the comparison. In particular, the conclusion rests on the relevant convexity and on comparing rate distributions in a way that preserves the appropriate central tendency; the brief answer does not discuss those qualifications.

Key ideas

• Bond values are convex functions of interest rates in the explanation given.
• Greater dispersion in rates can increase the expected value of a convex bond-price function.
• The answer presents this convexity intuition as independent of the Vasicek model.
• The source gives no derivation or detailed conditions for the volatility comparison.

Tags

# Vasicek model - Bond price and volatility


# Vasicek model - Bond price and volatility












Why does the bond price under the Vasicek model increase as the rate volatility increases? What is the intuition behind this?

## Answer by Arshdeep (score 5, accepted)

https://quant.stackexchange.com/a/55776

Intuition is just that the bond price by definition is a convex function of the rates, and the expectation of a convex function increases with volatility. Note that this result is model independent.

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.