What is the impact of positive convexity on bond prices?

Positive convexity refers to a characteristic of a bond's price responsiveness to changes in interest rates, which results in a price change that behaves in a nonlinear fashion. Specifically, when a bond has positive convexity, the relationship between bond prices and interest rates will lead to certain advantages.

When interest rates decrease, a bond with positive convexity will see its price increase more than it decreases in response to an equivalent rise in interest rates. This occurs because the curvature of the price-yield relationship allows it to capture more value when rates fall, thus leading to a greater price increase during rate declines.

Conversely, when interest rates rise, a bond with positive convexity will experience a price decrease that is less severe compared to a bond with negative convexity or zero convexity. This means that while the price of the bond still decreases when rates rise, the decrease is mitigated or less pronounced due to the positive convexity feature.

Therefore, the overall impact of positive convexity is that it both enhances the price increase when rates fall and reduces the price decrease when rates rise, making the bond less sensitive to interest rate increases and more responsive to interest rate decreases. This effect contributes to the bond's greater price stability in an environment of fluctuating interest rates