Convexity theory for the term structure equation (Q928497)

The aim of the paper is to continue the studies of the convexity and model parameter monotonicity properties for bonds and bond options for which the short rate is regarded as the underlying process. The preservation of convexity for the term structure equation is studied instead of variants of the Black-Scholes equation. The interest in convexity has many reasons. Firstly, the convexity is a fundamental qualitative property of option prices. Also, if the price is convex, then it is increasing in the volatility, and in jump parameters if they are non-zero. The convexity properties of the logarithm of the bond price is also considered. The log-convexity means that the relative decline diminishes as initial value grows. It is shown that if the drift is spatially concave and the diffusion is spatially grows then the log-convexity is preserved. Similar statement is proved for log-concavity.