DURATION, DEFAULT RISK, AND THE TERM STRUCTURE OF INTEREST RATES

We examine the interactive effect of default and interest rate risk on duration of defaultable bonds. We show that duration for defaultable bonds can be longer or shorter than default‐free bonds depending on the relation between default intensity and interest rates. Empirical evidence indicates that...

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Bibliographic Details
Published in:The Journal of financial research 2005-12, Vol.28 (4), p.539-554
Main Authors: Xie, Yan Alice, Liu, Sheen, Wu, Chunchi
Format: Article
Language:English
Subjects:
Bond portfolios
Default
G12
Interest rates
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Summary:We examine the interactive effect of default and interest rate risk on duration of defaultable bonds. We show that duration for defaultable bonds can be longer or shorter than default‐free bonds depending on the relation between default intensity and interest rates. Empirical evidence indicates that in most cases duration for defaultable bonds is much shorter than for their default‐free counterparts because of the negative relation between default risk and interest rates. Results suggest that the duration measure must be adjusted for the effects of default risk and stochastic interest rates to achieve an effective bond portfolio immunization.
ISSN:0270-2592
1475-6803
DOI:10.1111/j.1475-6803.2005.00138.x