Reduced-form valuation of callable corporate bonds: Theory and evidence
AbstractWe 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 both extends the reduced-form model of Duffie and Singleton (1999) for defaultable bonds to callable bonds and captures some important differences between call and default decisions. A comprehensive empirical analysis of callable bonds using both our model and the more traditional American option approach for valuing callable bonds shows that the reduced-form model fits callable bond prices well and that it outperforms the traditional approach both in- and out-of-sample.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Financial Economics.
Volume (Year): 95 (2010)
Issue (Month): 2 (February)
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Web page: http://www.elsevier.com/locate/inca/505576
Callable bond Reduced-form model Affine models;
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