tailieunhanh - ON THE VALUATION OF CORPORATE BONDS

Government bond turnover fell away from a peak in 2003 but has since recovered and is currently rising on a strong but volatile trend. Turnover of repurchase agreements (repo) continues to increase as more borrowers use them as a financing tool and is now considerably larger than government bond market turnover by investors (Figure 7). Illustrating the relative illiquidity of the government bond market is the low level of traded bonds—in the 12 months to July 2007 only 22 of the 95 bonds traded on more than 100 days and only 8 traded on more than 200 days. (Table 3) | ON THE VALUATION OF CORPORATE BONDS by Edwin J. Elton Martin J. Gruber Deepak Agrawal and Christopher Mann Nomura Professors New York University Doctoral students New York University 43 The valuation of corporate debt is an important issue in asset pricing. While there has been an enormous amount of theoretical modeling of corporate bond prices there has been relatively little empirical testing of these models. Recently there has been extensive development of rating based models as a type of reduced form model. These models take as a premise that groups of bonds can be identified which are homogeneous with respect to risk. For each risk group the models require estimates of several characteristics such as the spot yield curve the default probabilities and the recovery rate. These estimates are then used to compute the theoretical price for each bond in the group. The purpose of this article is to clarify some of the differences among these models to examine how well they explain prices and to examine how to group bonds to most effectively estimate prices. This article is divided into four sections. In the first section we explore two versions of rating-based models emphasizing their differences and similarities. The first version discounts promised cash flows at the spot rates that are estimated for the group in question. The second version uses estimates of risk-neutral default probabilities to define a set of certainty equivalent cash flows which are discounted at estimated government spot rates to arrive at a model price. The particular variant of this second model we will use was developed by Jarrow Lando and Turnbull 1997 . In the second section of this paper we explore how well these models explain actual prices. In this section we accept Moody s ratings along with classification as an industrial or financial firm as sufficient metrics for grouping. In the next section we examine what additional characteristics of bonds beyond Moody s classification are .

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