On the Pricing and Early Call of American and Bermudan Callable Bonds
26 Pages Posted: 5 Nov 2012
Date Written: March 1, 2012
This paper reconsiders American and Bermudan callable bonds and highlights their key differences. We illustrate how the level of interest rate critical for calling Bermudan Callable Bonds (BCBs) can differ from those critical for calling American Callable Bonds (ACBs). We also stress that it is costly for ACB issuers to follow a discrete early call policy. An empirical simulation finally suggests that every US bond issuer having included a call provision between 1993 and 2011 would have called back their debt especially those holding a Bermudan style redemption option. Compared to ACBs, BCBs can more favorably face unexpected changes of the term structure of interest rates. We observe that a discrete monitoring policy for ACBs may be approximately as profitable as the Bermudan regular call policy, but BCBs are less expensive than ACBs at issuance. Our empirical simulation explains why investors require call deferment periods in call provisions.
JEL Classification: G12, G17, G34
Suggested Citation: Suggested Citation
By Xiaowei Kang