Duration, Default Risk, and the Term Structure of Interest Rates

Posted: 22 Nov 2004

See all articles by Yan Alice Xie

Yan Alice Xie

University of Michigan at Dearborn

Sheen Liu

Youngstown State University - Williamson College of Business Administration

Chunchi Wu

SUNY at Buffalo - School of Management

Abstract

We examine the interactive effect of default and interest rate risk on duration of defaultable bonds. We show that duration for defaultable bonds can be longer or shorter than default-free bonds depending on the relation between default intensity and interest rates. Empirical evidence indicates that in most cases duration for defaultable bonds is much shorter than for default-free counterparts because of the negative relation between default risk and interest rates. Results suggest that the duration measure must be adjusted for the effects of default risk and stochastic interest rates to achieve an effective bond portfolio immunization.

Keywords: Default risk, bond pricing, duration, term structure

Suggested Citation

Xie, Yan and Liu, Sheen and Wu, Chunchi, Duration, Default Risk, and the Term Structure of Interest Rates. Available at SSRN: https://ssrn.com/abstract=621722

Yan Xie

University of Michigan at Dearborn ( email )

Dearborn, MI
United States

Sheen Liu

Youngstown State University - Williamson College of Business Administration ( email )

Youngstown, OH 44555
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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