On the Pricing of Step-Up Bonds in the European Telecom Sector

David Lando and Allan Mortensen
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Allan Mortensen: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark

No 2004-9, Working Papers from Copenhagen Business School, Department of Finance

Abstract: This paper investigates the pricing of step-up bonds, i.e. corporate bonds with provisions stating that the coupon payments increase as the credit rating level of the issuer declines. To assess the risk-neutral rating transition probabilities necessary to price these bonds, we introduce a new calibration method within the reduced-form rating-based model of Jarrow, Lando, and Turnbull (1997). We also treat split ratings and adjust for rating outlook. Step-up bonds have been issued in large amounts in the European telecom sector, and we find that, through most of the sample, step-up bonds issued by the two largest issuers have traded at a discount relative to comparable fixed-coupon bonds from the same issuers. Our findings cannot be attributed to traditional liquidity factors, and they suggest that issuing step-up bonds increased the cost of capital for the issuers.

Keywords: defaultable bonds; step-up coupons; rating-based models (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2004-11-12
New Economics Papers: this item is included in nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:hhs:cbsfin:2004_009

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