Random discussion I’m in at work… Please settle. View 1) A fairly priced bond with higher credit risk will exhibit more absolute convexity (i.e., positive or negative) than a fairly priced bond with less credit risk given a change in yield all else equal. View 2) Regardless of credit risk fairly priced bonds exhibit the same absolute convexity (i.e., positive or negative) given a change in yield all else equal. What do y’all think? Thanks, CF_AHHHHHHHHH
This is just my attempt to answer the question (experts, feel free to jump in): In theory, view 2 applies since credit risk (measured by say OAS) does not have a direct impact on duration and convexity But in practice, view 1 sometimes hold true since credit events might be somewhat correlated with duration/convexity… (I can’t think of any examples, but having one will definitely help illustrate this dynamics). This is, of course, assuming close to par (i.e., not in a distressed situation). edit; oops, got the views swapped
#2- the highers price volatility you see on bonds with higher credit risk is due to credit spreads changes not interest rate changes.
If the bond is a coupon bond, then a credit bond is going to have a higher coupon rate than a non-credit bond with equally timed cash flows. That higher coupon is going to give you more convexity.