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Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy

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  • Acharya, Viral
  • Carpenter, Jennifer

Abstract

This Paper analyses corporate bond valuation and optimal call and default rules when interest rates and firm value are stochastic. It then uses the results to explain the dynamics of hedging. Bankruptcy rules are important determinants of corporate bond sensitivity to interest rates and firm value. Although endogenous and exogenous bankruptcy models can be calibrated to produce the same prices, they can have very different hedging implications. We show that empirical results on the relation between corporate spreads and Treasury rates provide evidence on duration and find that the endogenous model explains the empirical patterns better than typical exogenous models.

Suggested Citation

  • Acharya, Viral & Carpenter, Jennifer, 2002. "Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy," CEPR Discussion Papers 3328, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:3328
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    More about this item

    Keywords

    Corporate bonds; Call; Default; Stochastic interest rates; Endogenous bankruptcy; Optimal exercise boundary; Hedging; Duration;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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