Abstract
Fixed-income market participants have become keenly aware that movements in Treasury rates are amplified by hedging activities arising from of the mortgage market. That is, as interest rates rise or fall, mortgage market convexity hedgers are forced to sell or buy bonds, which then exacerbates interest rate moves. Certain structural changes in the fixed-income market have over time resulted in more convexity hedging. Different types of convexity hedgers—investors, servicers, and originators—have differing convexity needs. Convexity hedging needs are much more muted in a high rate environment. The authors look at the total convexity needs of the market over time, with particular emphasis on Summer 2003, when rates rose considerably in a short time, and market participants attributed the rise to the impact of the convexity hedgers.
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