Default Risk and the Duration of Zero Coupon Bonds



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    • Department of Finance, Insurance and Business Law, The R. B. Pamplin College of Business, Virginia Polytechnic Institute & State University. The author would like to thank Mark Garman, Tom O'Brien, Jack Broughton, Steve Buser (the co-editor), René Stulz (the editor), and two anonymous referees for helpful comments and suggestions. Support was provided by a summer research grant from the VPI Department of Finance.


This paper applies a contingent claims approach to examine the duration of a zero coupon bond subject to default risk. One replicating portfolio for a default-prone zero coupon bond contains a long position in the default-free asset plus a short position in a put option on the underlying assets. The duration of the bond is shown to be a weighted combination of the duration of the default-free bond and the put option. The duration is less than maturity and is not an immunizing duration. The technique is then extended to subordinated debt.