Duration, Convexity and Higher Order Hedging (Revisited)

Abstract:     
Here the concepts of Duration and Convexity are studied when the term structure at a single point in time generally cannot be summarized by a finite number of state variables. Hence it is unclear whether calculating Duration and Convexity from partial derivatives makes sense. In this paper definitions of Duration and Convexity are provided that circumvent this problem and consistency with traditional measures is shown. The information required to compute Duration as defined in this paper consists of the term structure and the volatility of zero-coupon bonds. Convexity additionally requires a model of how this volatility will change over time. Schemes for calculating Duration and Convexity in practice are provided

JEL Classifications: G11, G12, G13

Working Paper Series