Convexity Adjustment for Constant Maturity Swaps

Both CMS (Constant Maturity Swap) and LIBOR-in-arrears swaps have payments that are linear with respect to an index while the offsetting hedges are convex. The linearity of the payment (relative to the convex hedges) imposes a cost that requires a “convexity adjustment” applied to the linear payment.  This note lays out a practical method for calculating the value of the convexity adjustment.

This paper was published in Derivatives Quarterly, Winter 1995. A copy, as a 15-page .pdf, is available on the CloseMountain site

A three-page summary outlines the “convexity adjustment” applied to constant maturity swaps. Published in Derivatives Weekly August 28th 1995, a copy is available here on the CloseMountain site

About Thomas Coleman

Thomas S. Coleman is Senior Advisor at the Becker Friedman Institute for Research in Economics and Adjunct Professor of Finance at the Booth School of Business at the University of Chicago. Prior to returning to academia, Mr. Coleman worked in the finance industry for more than twenty years with considerable experience in trading, risk management, and quantitative modeling. Mr. Coleman earned a PhD in economics from the University of Chicago and a BA in physics from Harvard College.
This entry was posted in Publications and Papers, Valuation and Modeling and tagged . Bookmark the permalink.

Leave a Reply