Working Paper: CEPR ID: DP3328
Authors: Viral V. Acharya; Jennifer Carpenter
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.
Keywords: call; corporate bonds; default; duration; endogenous bankruptcy; hedging; optimal exercise boundary; stochastic interest rates
JEL Codes: G12; G13; G31; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bankruptcy rules (K35) | corporate bond sensitivity to interest rates (E43) |
| bankruptcy rules (K35) | firm value (G32) |
| endogenous bankruptcy models (G33) | bond pricing (G12) |
| endogenous bankruptcy models (G33) | hedging strategies (G13) |
| corporate yield spreads (G39) | treasury rates (E43) |
| interest rate changes (E43) | bond pricing dynamics (G12) |
| call provisions and default risk (G33) | bond pricing (G12) |
| sensitivity of bond prices to firm value (G32) | default risk (G33) |
| optimal call and default policies (E61) | duration and yield spreads (E43) |