Strictly speaking, convexity refers to the second derivative of output price with respect to an input price. In derivative pricing, this is referred to as Gamma (Γ), one of the Greeks. In practice the most significant of these is See more

The convexity can be used to interpret derivative pricing: mathematically, convexity is optionality – the price of an option (the value of optionality) corresponds to the convexity of the underlying payout.
In See more

Formally, the convexity adjustment arises from the Jensen inequality in probability theory: the expected value of a convex function is greater than or equal to the function of the expected value:
$${\displaystyle E[f(X)]\geq f(E[X]).}$$
Geometrically, if … See more

From a modeling perspective, convexity adjustments arise every time the underlying financial variables modeled are not a See more