Convexity, Risk, and Returns

16 Pages Posted: 30 Apr 2007

See all articles by Nelson Lacey

Nelson Lacey

University of Massachusetts at Amherst

Sanjay K. Nawalkha

University of Massachusetts Amherst - Isenberg School of Management

Date Written: March 1993


This paper tests empirically whether convexity is return enhancing (the traditional view based upon parallel term structure shifts), or return diminishing (the equilibrium view suggesting convexity is priced). Results of empirical tests over different time periods show bond convexity to be either insignificantly or negatively related to ex-ante bond returns. These results are consistent with the critique of the traditional duration model by Ingersoll, Skelton, and Weil [1978] and suggest that bond convexity may be priced. Further, the magnitude of bond convexity is shown to be related directly to the immunization risk inherent in a bond portfolio, consistent with the implications of Fong and Vasicek's [1983, 1984] M-Square model.

Keywords: Convexity, risk, immunization, bonds, M-Square, hedging

JEL Classification: G11, G12, G13, G21, G22, G32

Suggested Citation

Lacey, Nelson J. and Nawalkha, Sanjay K., Convexity, Risk, and Returns (March 1993). Available at SSRN: or

Nelson J. Lacey

University of Massachusetts at Amherst ( email )

School of Management
Amherst, MA 01003
United States
413-545-5630 (Phone)
413-545-3858 (Fax)

Sanjay K. Nawalkha (Contact Author)

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States
413-687-2561 (Phone)

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