Bond Systematic Risk and the Option Pricing Model



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    • School of Business Administration, University of Southern California, Los Angeles, CA 90089. Much of the work presented here was conducted while the author was visiting at Columbia and New York Universities. This paper has benefited from presentations at Columbia, NYU, UCLA, and the University of Southern California as well as from the comments of Richard Roll, Alan Hess, and the editor of the Journal of Finance. The usual disclaimer applies.


In this paper we examine the behavior of the systematic risk of corporate bonds. A model that assumes β is constant is compared with a model that allows systematic risk to vary in a manner consistent with the Black-Scholes-Merton Options Pricing Model. This procedure captures some fundamental properties of the movement of bond β and provides a starting point for improved models of the process generating bond returns.