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Estimating the Term Structure of Yield Spreads from Callable Corporate Bond Price Data

by Antje Berndt of Cornell University

December 16, 2004

Abstract: I extract credit pricing information from the prices of callable corporate debt, by disentangling the components of callable corporate bond prices associated with discounting at market interest rates, discounting for default risk, and optionality. The results include the first empirical analysis, in the setting of standard arbitrage-free termucture models, of the time-series behavior of callable corporate bond yield spreads, explicitly incorporating the valuation of the American call options. As an application, I consider medium-quality callable issues of Occidental Petroleum Corporation, using a three-factor model for the term structures of benchmark (LIBOR-dollar) swap rates and for Occidental yield spreads.

JEL Classification: E43, G12, G13.

Keywords: Callable Corporate Bond, Credit Spread, American Option, Term Structure Model, Maximum Likelihood Estimation.

Previously titled: Estimating the Term Structure of Credit Spreads: Callable Corporate Debt

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