Default Risk for Bonds with a Make Whole Call Provision

Posted: 11 Mar 2013

See all articles by Olfa Maalaoui Chun

Olfa Maalaoui Chun

Korea Advanced Institute of Science and Technology (KAIST) - Graduate School of Finance

Date Written: November 12, 2012

Abstract

We estimate the default probabilities implicit in the transaction prices of a new type of call provision, the make whole call. The new issuance of make whole callable bonds has supplanted that of traditional callable bonds and noncallable bonds. Make whole callable bonds have strike prices that vary inversely with the short rate, providing a natural hedge against interest rate risk and offering an attractive investment opportunity. Insurer trading activity has recently shifted from noncallable bonds to make whole callable bonds. Insurers are limited in their risk taking; therefore their preference for make whole bonds should reflect the creditworthiness of these securities.

Keywords: make whole call provision, time-varying strike price, default probability

JEL Classification: C6, C13, G12, G13

Suggested Citation

Maalaoui Chun, Olfa, Default Risk for Bonds with a Make Whole Call Provision (November 12, 2012). Available at SSRN: https://ssrn.com/abstract=2231047 or http://dx.doi.org/10.2139/ssrn.2231047

Olfa Maalaoui Chun (Contact Author)

Korea Advanced Institute of Science and Technology (KAIST) - Graduate School of Finance ( email )

207-43 Cheongryangri-2dong 130-722
Seoul
Korea

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