The Default Risk of High-Yield Bonds

Abstract:     
This paper investigates the default behavior of original issue rated non-convertible high-yield bonds. Previous studies of high-yield bond defaults provide evidence of an aging effect: the longer bonds have been outstanding, the greater the default probability. However, Blume, Keim and Patel (1991) assert that this aging relationship reflects changing economic conditions. This study of bond defaults discriminates between the aging effect and the impact of macroeconomic changes. A hazard model is used to simultaneously estimate the impact of bond age, firm-specific and issue-specific characteristics, and changing economic conditions. The specification models the impact of time since issuance semi-parametrically, corrects for unobserved heterogeneity and allows for the possibility that outstanding bonds may default in the future. Our findings, based on a sample of 579 individual high-yield bonds issued between 1977 and 1989, suggest that, after controlling for annual changes in economic conditions, default rates increase with age. Bond characteristics at the time of issuance also impact the default behavior: BB rated bonds tend to have significantly lower default rates compared to CCC rated bonds; bonds with higher coupon rates have significantly higher default rates. In addition, high-yield bonds issued prior to 1980 experienced significantly lower default rates.

JEL Classification: G19, G33, C41

working papers series