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

45 Pages Posted: 22 Mar 2007

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

Youngstown State University - Williamson College of Business Administration

Chunchi Wu

SUNY at Buffalo - School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: October 2006

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 extends the reduced-form model of Duffie and Singleton (1999) for defaultable bonds to callable bonds and can capture some important differences between call and default decisions.We also provide one of the first comprehensive empirical analyses of callable bonds using both our approach and the traditional approach of valuing callable bonds as American options. Empirical results show that the reduced-form model fits callable bond price data well and outperforms the traditional approach in both in-sample and out-of-sample applications.

Keywords: Callable bond, reduced-form

JEL Classification: C4,C5,G1

Suggested Citation

Jarrow, Robert A. and Li, Haitao and Liu, Sheen and Wu, Chunchi, Reduced-Form Valuation of Callable Corporate Bonds: Theory and Evidence (October 2006). Available at SSRN: https://ssrn.com/abstract=972121 or http://dx.doi.org/10.2139/ssrn.972121

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 (Contact Author)

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

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

Youngstown, OH 44555
United States

Chunchi Wu

SUNY at Buffalo - School of Management ( email )

Jacobs Management Center
Buffalo, NY 14222
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
590
Abstract Views
2,296
rank
23,621
PlumX Metrics