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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MDPI AG
2025-04-01
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| Series: | Risks |
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| Online Access: | https://www.mdpi.com/2227-9091/13/4/69 |
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| author | Scott S. Dow Stefanos C. Orfanos |
| author_facet | Scott S. Dow Stefanos C. Orfanos |
| author_sort | Scott S. Dow |
| collection | DOAJ |
| description | 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. |
| format | Article |
| id | doaj-art-9d4fdfcca8e1475c8202a4dbd8b40545 |
| institution | DOAJ |
| issn | 2227-9091 |
| language | English |
| publishDate | 2025-04-01 |
| publisher | MDPI AG |
| record_format | Article |
| series | Risks |
| spelling | doaj-art-9d4fdfcca8e1475c8202a4dbd8b405452025-08-20T03:13:48ZengMDPI AGRisks2227-90912025-04-011346910.3390/risks13040069Interest Rate Sensitivity of Callable Bonds and Higher-Order ApproximationsScott S. Dow0Stefanos C. Orfanos1M. R. Greenberg School of Risk Science, J. Mack Robinson College of Business, Georgia State University, Atlanta, GA 30302, USAM. R. Greenberg School of Risk Science, J. Mack Robinson College of Business, Georgia State University, Atlanta, GA 30302, USACertain 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.https://www.mdpi.com/2227-9091/13/4/69bond agilitybond tilthigher-order approximationsnegative convexity bonds |
| spellingShingle | Scott S. Dow Stefanos C. Orfanos Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations Risks bond agility bond tilt higher-order approximations negative convexity bonds |
| title | Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations |
| title_full | Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations |
| title_fullStr | Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations |
| title_full_unstemmed | Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations |
| title_short | Interest Rate Sensitivity of Callable Bonds and Higher-Order Approximations |
| title_sort | interest rate sensitivity of callable bonds and higher order approximations |
| topic | bond agility bond tilt higher-order approximations negative convexity bonds |
| url | https://www.mdpi.com/2227-9091/13/4/69 |
| work_keys_str_mv | AT scottsdow interestratesensitivityofcallablebondsandhigherorderapproximations AT stefanoscorfanos interestratesensitivityofcallablebondsandhigherorderapproximations |