On the Pricing of Step-Up Bonds in the European Telecom Sector

42 Pages Posted: 14 May 2004

See all articles by David Lando

David Lando

Copenhagen Business School

Allan Mortensen

Independent; Copenhagen Business School

Date Written: December 22, 2003

Abstract

This paper investigates the pricing of step-up bonds, i.e. corporate bonds with provisions stating that the coupon payments increase as the credit rating level of the issuer declines. To assess the risk-neutral rating transition probabilities necessary to price these bonds, we introduce a new calibration method within the reduced-form rating-based model of Jarrow, Lando, and Turnbull (1997). We also treat split ratings and adjust for rating outlook. Step-up bonds have been issued in large amounts in the European telecom sector, and we find that, through most of the sample, step-up bonds issued by the two largest issuers have traded at a discount relative to comparable fixed-coupon bonds from the same issuers. Our findings cannot be attributed to traditional liquidity factors, and they suggest that issuing step-up bonds increased the cost of capital for the issuers.

Keywords: defaultable bonds, step-up coupons, rating-based calibration

JEL Classification: G12, G13

Suggested Citation

Lando, David and Mortensen, Allan, On the Pricing of Step-Up Bonds in the European Telecom Sector (December 22, 2003). EFMA 2004 Basel Meetings Paper. Available at SSRN: https://ssrn.com/abstract=495562 or http://dx.doi.org/10.2139/ssrn.495562

David Lando

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45 3815 3600 (Fax)

Allan Mortensen (Contact Author)

Independent ( email )

No Address Available

Copenhagen Business School ( email )

DK - 2000 Frederiksberg C
Denmark

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