Valuation of Callable/Putable Corporate Bonds in a One-Factor Lognormal Interest-Rate Model

Goldberg, Robert S.; Ronn, Ehud I.; Xu, Liying

doi:10.3905/jfi.2021.1.111

Cited by 1 publication

(2 citation statements)

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“…The pricing of bonds with an embedded option has been attracting a lot of research interest recently (Goldberg et al, 2021;François & Pardo, 2015;Lim et al, 2012;Jarrow et al, 2010;Banko & Zhou, 2010). The researchers agree that the task is challenging due to discontinuities in the "bond value" or "its derivative at call and/or notice dates" (for details, see D 'Halluin et al, 2001).…”

Section: Literature Reviewmentioning

confidence: 99%

“…Faced with the increasing importance of below investment-grade callable bonds, a growing body of academic literature examines the issue how to value a callable bond (Goldberg et al, 2021;François & Pardo, 2015;Lim et al, 2012;Jarrow et al, 2010;Banko & Zhou, 2010;Xie, 2009;Ben-Ameur et al, 2007;D'Halluin et al, 2001;Duffie & Singleton, 1999;Büttler & Waldvogel, 1996;Büttler, 1995;Ho et al, 1992;Hull & White, 1990Katolay et al, 1993;Brennan & Schwartz, 1977). The seminal work by Dai and Singleton (2000) can be recalled here to point out that the vast majority of prior studies have dealt with non-callable bonds, although "the majority of dollar-denominated corporate bonds are callable" (Jarrow et al, 2010).…”

Section: Introductionmentioning

confidence: 99%

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Valuation of Embedded Options in Non-Marketable Callable Bonds: A New Numerical Approach

Skalický

Zinecker

Balcerzak

et al. 2022

Technological and Economic Development of Economy

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The issue of how to price options embedded in callable bonds has attracted a lot of interest over the years. The usual bond valuation methods rely on yield curves, risk premium, and other parameters to estimate interest rates used in discounted cash flow calculations. The option to retire the bond is, however, neglected in the standard pricing models, causing a systematic overvaluation of callable bonds. In the event of a decline in interest rates, investors are exposed to the risk of a lower return on investment than indicated by the yield to maturity. We propose a novel approach to valuing the risk that the issuer will use the right to buy back the bond at a specific call price. While prior models are focused on valuing marketable callable bonds, we deliver a unique approach to valuing bonds with an embedded European option (or a multiple option) that are traded solely through private transactions. These can typically be characterized by the lack of historical records on transaction prices. The modular character of calculation we propose allows us to take into account additional information, such as probable behaviour of the issuer, available opportunities for achieving alternative earnings or different estimates in terms of interest rate development.

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