2013 MOCK AM 8D

"“In this case, however, the convexity of the liabilities is less than the convexity of the assets. Therefore, the decline in value of the liabilities as a result of the yield curve shift will be greater than the decline in value of the assets, thus increasing economic surplus.”

There is an 75bps upward parallel shift in the yield curve and the convexit of assets is greater than convexity of liabilities although the assets and liabilities are duration matched.

Why does the convexitiy affect the surplus that way? I thought that since the convexity of the assets is greater, it would mean that the decline in value of the assets would be greater??

What am I missing?

Higher convexity would mean assets would decrease less than liabilities for a given downward shift in interest rates

this will help.


the chart explains it pretty well.