Question states that high coupon bonds will exhibit greater negative convexity if interest rates decline than low coupon bonds (will perform worse). I was thinking the other way around. Any help appreciated.
The higher the coupon rate the more likely (earlier) the bond will be called, hence the bond will exhibit greater negative convexity if interest rates decline.
Your thinking is correct but for a vanilla bonds such as 30 yr old notes. You are talking about positive convexity The example is talking about mortgage securities which are negatively convex. An example is given here: http://bp0.blogger.com/_kQmcDGJ6WuI/R59L6NP_DsI/AAAAAAAAAJU/kweZjnX4x1M/s400/Convexity_edited-1.jpg
Callable or MBS with prepayment option will exhibit negative convexity if interest rates decline. Option-free bonds will only positive convexity.
Mortgage holder #1 has a 30 yr fixed rate loan at 6.5% Mortgage holder #2 has a 30 yr fixed rate loan at 5% Current mortgage rates are at 4.5% - who is more likely to refinance (ie. exercise the call option on their loan)? Since the bond issuer (borrower) with a higher coupon is more likely to exercise a call option - higher coupon bonds are more likely to display neg C than lower coupon bonds.