Hello. I have a big doubt relating bond portfolio strategy and convexity.
I read that when focusing in a ALM (asset liability management) re require less convexity (when convexity is suopose to be good) why is this?
On the other hand, which type of startegy has the greter convexity? Laddered, Barbell of bullet?
So… for a ALM which strategy is better?
Looking forward a response,
Best
Convexity of the asset should be larger than the convexity of the liability. That said, however, introducing convexity also introduces structural risk, that is, mismatches in the hedging portfolio when there is a twist in the curve. The idea is to minimize the excess convexity (that is, the convexity of asset over and above the convexity of liability).
Barbell has the largest convexity (relatively speaking), followed by laddered, and finally bullet.
There is not one strategy that is better than another. You will need to look at multiple factors, on of the most important being the future expectations of the yield curve. Barbell structure tends to outperform on a flattening yield curve, whereas bullet tends to outperform on a steepening yield curve.
As I could understand convexity means more dispersion.
When immunizing a single liability: you take the portfolio that matches liabilities BPV and with with the lowest convexity (here you want less dispersion)
When immunizing multiple liabilities, after matching BPV you need to take a portfolio with higher convexity than liabilities. If you still get 2 or more, then you take the one with lower convexity but above liabilities convexity.
Do you guys agree? This is what I got solving EOC questions of this reading.
In the context of duration matching, I agree.