What risks do corporate bond put features insure against?
Article first published online: 6 SEP 2011
© 2012 Wiley Periodicals, Inc.
Journal of Futures Markets
Volume 32, Issue 11, pages 1060–1090, November 2012
How to Cite
Elkamhi, R., Ericsson, J. and Wang, H. (2012), What risks do corporate bond put features insure against?. J. Fut. Mark., 32: 1060–1090. doi: 10.1002/fut.20546
- Issue published online: 10 AUG 2012
- Article first published online: 6 SEP 2011
- Manuscript Accepted: 24 JUL 2011
- Manuscript Received: 25 JAN 2011
Corporate bond prices are known to be influenced by default and term structure risk in addition to non-default risks such as illiquidity. Putable corporate bonds allow investors to sell their holdings back to the issuer and may thus provide insurance against all of these risks. We first document empirically that embedded put option values are related to proxies for all three. In a second step, we develop a valuation model that simultaneously captures default and interest rate risk. We use this model to disentangle the reduction in yield spread enjoyed by putable bonds that can be attributed to each risk. Perhaps surprisingly, the most important reduction is due to mitigated default or spread risk, followed by term structure risk. The reduction in the non-default component is present but rather small.