The volatility puzzle of bonds

Abstract

In this financial engineering research we newly derive that a market price volatility of a typical coupon bond is not always deterministically decreasing during its life (investors’ common concept); but we also identify a non-typical volatility development style which is characterized by a deterministic increase of volatility during its life to maturity. In addition: we also numerically calculate value of the “switching” points between these two styles with respect to the economic interest rates level and parameters of adequate bond. The purpose of this study is also to simplify for practitioners a complicated theoretical background of this portfolio management issue. The results of this research are also applicable to a bond portfolio behaviour at a certain point of time.