Callable Bonds
Callable bonds are debt securities that give the issuer the right, but not the obligation, to redeem the bond before its stated maturity date. This option is typically exercised when interest rates fall, allowing the issuer to refinance their debt at a lower cost.
The presence of a call option means that callable bonds exhibit Negative Convexity (MBS). When interest rates decline, the bond's price appreciation is limited by its call price, as the issuer is likely to call the bond. This behavior is analogous to how the prepayment option in mortgages causes negative convexity in Other Loan Participants and Key Third Parties in the Mortgage Ecosystem.
Many municipal bonds are callable and therefore exhibit this embedded negative convexity.
References
- Vanguard. "Negative convexity in municipal bonds: The new rate regime and ..." corporate.vanguard.com.
- Touro University. "9.38 Negative Convexity – Fixed Income Mathematics." touro.pressbooks.pub.
Source material
- research add cross references to conceptsnegative convexity 2026 05 17
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