Convexity

Convexity is a measure used in finance to describe how the value of a bond or investment responds to changes in interest rates. It captures the curvature in the relationship between bond prices and interest rates, indicating how much the duration (price sensitivity) will change when rates fluctuate. Higher convexity means the bond's price is less sensitive to interest rate increases and more responsive to decreases, providing a cushion against rate movements. In essence, convexity helps investors understand the risk and potential price changes of bonds with respect to interest rate changes, improving the accuracy of price predictions beyond simple duration estimates.