Default Risk for Bonds with a Make Whole Call Provision
Posted: 11 Mar 2013
Date Written: November 12, 2012
Abstract
We estimate the default probabilities implicit in the transaction prices of a new type of call provision, the make whole call. The new issuance of make whole callable bonds has supplanted that of traditional callable bonds and noncallable bonds. Make whole callable bonds have strike prices that vary inversely with the short rate, providing a natural hedge against interest rate risk and offering an attractive investment opportunity. Insurer trading activity has recently shifted from noncallable bonds to make whole callable bonds. Insurers are limited in their risk taking; therefore their preference for make whole bonds should reflect the creditworthiness of these securities.
Keywords: make whole call provision, time-varying strike price, default probability
JEL Classification: C6, C13, G12, G13
Suggested Citation: Suggested Citation
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