IS BOND CONVEXITY A FREE LUNCH - IMMUNIZATION DOES NOT IMPLY RISK-FREE ARBITRAGE PROFITS

A common criticism of immunization theory is that the convexity proper ty of an immunized portfolio provides investors with a ''free lunch.'' The traditional theory, the authors argue, does not have the power to prove this assertion because it does not consider the effect of time changes on portfolio value. By explicitly including time in the term s tructure model and examining an immunized portfolio at future dates, t he authors show that bond convexity is consistent with arbitrage-free pricing. This result provides theoretical support for empirical work i ndicating that the objective of pursuing convexity does not result in superior portfolio performance.