bond volatility question

Kevinwdong · October 21st, 2003, 8:13 pm

In Hull's book (options... 4th edition p536), there is a formula to calculate bond volatility from yiedl volatility but the formula is only considering duration term. What would be the formula if convexity term is also considered? Looks like a easy question but I found it's not easy to ask. Hope I can get good inputs from your guys. Thanks!

elan · October 21st, 2003, 8:54 pm

Convexity doesn't enter the relation between price vol and yield vol. It affects the drift term in the process for the price of the bond. You can easily calculate this convexity correction using Ito's lemma. Because it is very small, the convexity correction to the drift is usually neglected.

Kevinwdong · October 22nd, 2003, 1:46 pm

the convexity corretion will change bond price even it's small. Why there is no change on bond volatility?

elan · October 22nd, 2003, 2:18 pm

Please reread my posting and do the math I recommend doing.

liefje · October 23rd, 2003, 7:04 am

which Hull's formula are you referring to?

Graeme · October 23rd, 2003, 6:04 pm

(22.6) in Hull 5. The way I remember things, THIS formula follows from Ito as well (as the drift stuff Elan has pointed out).

elan · October 23rd, 2003, 8:18 pm

QuoteOriginally posted by: Graeme(22.6) in Hull 5. The way I remember things, THIS formula follows from Ito as well (as the drift stuff Elan has pointed out).Here is a back of the envelope calculation.