Callable bonds contain
negative convexity which may be defined as a characteristic of a bond, when the price appreciation is less than the price depreciation, for a large change in interest rates.
It has a similar maturity risk to the underlying mortgage but, because of its
negative convexity, has a much greater volatility of return as expected maturity ebbs and flows.
Indeed, to compensate
negative convexity effects, buying options (in other words, buying positive convexity) on the asset side is a decision that deserves careful consideration.
They provide the positive duration and positive convexity needed to offset the negative duration and
negative convexity of mortgage servicing, says Shaiman.
This imparts less
negative convexity to most CMBS issues than residential MBS.
Negative convexity refers to the phenomenon that for a given change in overall market interest rates, prices of mortgage-backed securities or servicing rights decline faster than the change in market yields.
Mitigation of negative duration and (often)
negative convexityBecause interest rates had been on a steady uptrend for years, pipeline fallout and
negative convexity were merely academic concepts.
