Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations
Certain fixed-income securities, such as callable bonds and mortgage-backed securities subject to prepayment, typically exhibit negative convexity at low yields and cannot be adequately immunized through duration and convexity-matching alone. To address this residual risk, we examine the concepts of...
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| Main Authors: | , |
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| Format: | Article |
| Language: | English |
| Published: |
MDPI AG
2025-04-01
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| Series: | Risks |
| Subjects: | |
| Online Access: | https://www.mdpi.com/2227-9091/13/4/69 |
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| Summary: | Certain fixed-income securities, such as callable bonds and mortgage-backed securities subject to prepayment, typically exhibit negative convexity at low yields and cannot be adequately immunized through duration and convexity-matching alone. To address this residual risk, we examine the concepts of bond tilt and bond agility. We provide explicit calculations and derive several approximation formulas that incorporate higher-order terms. With the help of these methods, we are able to track the price-yield dynamics of callable bonds remarkably well, achieving mean absolute errors below 2.5% across a wide variety of callable bonds for parallel yield shifts of up to ±200 basis points. |
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| ISSN: | 2227-9091 |