Convexity Adjustments

ENCYCLOPEDIA OF QUANTITATIVE FINANCE, R. Cont, ed., Wiley, 2009

Posted: 7 Mar 2009 Last revised: 6 May 2009

See all articles by Raquel M. Gaspar

Raquel M. Gaspar

ISEG and Cemapre/REM, Universidade de Lisboa

Agatha Murgoci

Aarhus University - School of Business and Social Sciences

Date Written: March 6, 2009

Abstract

A convexity adjustment (or convexity correction) in fixed income markets arises when one uses prices of standard (plain vanilla) products plus an adjustment to price nonstandard products. We explain the basic and appealing idea behind the use of convexity adjustments and focus on the situations of particular importance to practitioners: yield convexity adjustments, forward versus futures convexity adjustments, timing and quanto convexity adjustments. We claim that the appropriate way to look into any of these adjustments is as a side effect of a measure change, as proposed by Pelsser (2003). This approach bypasses the need for Taylor approximations or unrealistic assumptions.

Keywords: convexity adjustment, LIBOR rate, swap rates, in-arrears products, CMS, forward price, futures

JEL Classification: E43,G12

Suggested Citation

Gaspar, Raquel M. and Murgoci, Agatha, Convexity Adjustments (March 6, 2009). ENCYCLOPEDIA OF QUANTITATIVE FINANCE, R. Cont, ed., Wiley, 2009, Available at SSRN: https://ssrn.com/abstract=1354735

Raquel M. Gaspar (Contact Author)

ISEG and Cemapre/REM, Universidade de Lisboa ( email )

Rua Miguel Lupi, 20
room 510
Lisbon, 1249-078
Portugal

Agatha Murgoci

Aarhus University - School of Business and Social Sciences ( email )

Nordre Ringgade 1
Aarhus C, DK-8000
Denmark

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