Reduced-Form Valuation of Callable Corporate Bonds: Theory and Evidence

44 Pages Posted: 25 Mar 2008 Last revised: 12 Oct 2008

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Haitao Li

University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business; Cheung Kong Graduate School of Business

Sheen Liu

Washington State University - Vancouver

Chunchi Wu

SUNY at Buffalo - School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: March 18, 2008

Abstract

We develop a reduced-form approach for valuing callable corporate bonds by characterizing the call probability via an intensity process. Asymmetric information and market frictions justify the existence of a call-arrival intensity from the market's perspective. Our approach both extends the reduced-form model of Duffie and Singleton (1999) for defaultable bonds to callable bonds and captures some important differences between call and default decisions. We also provide one of the first comprehensive empirical analyses of callable bonds using both our model and the more traditional American option approach for valuing callable bonds. Our empirical results show that the reduced-form model fits callable bond prices well and that it outperforms the traditional approach both in- and out-of-sample.

Suggested Citation

Jarrow, Robert A. and Li, Haitao and Liu, Sheen and Wu, Chunchi, Reduced-Form Valuation of Callable Corporate Bonds: Theory and Evidence (March 18, 2008). AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1108745 or http://dx.doi.org/10.2139/ssrn.1108745

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Haitao Li

University of Michigan - Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-615-5475 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Sheen Liu

Washington State University - Vancouver ( email )

14204 NE Salmon Creek Ave.
Vancouver, WA 98686
United States

Chunchi Wu (Contact Author)

SUNY at Buffalo - School of Management ( email )

Jacobs Management Center
Buffalo, NY 14222
United States

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