Essays on corporate bonds

This thesis consists of three empirical essays on corporate bonds, examining the role of both credit risk and liquidity. In the first chapter, I test the ability of structural models of default to price corporate bonds in the cross-section. I find that the Black-Cox model can explain 45% of the cross-sectional variation in yield spreads. The unexplained portion is correlated with proxies for credit risk and thus, cannot be attributed solely to non-credit components such as liquidity. I then calibrate a .jump diffusion model and a stochastic volatility model, finding that the jump diffusion model weakly improves cross-sectional explanatory power while the stochastic volatility model does not. However, much of the cross-sectional variation in yield spreads remains unexplained by structural models. In the second chapter (co-authored with Jun Pan), we examine the connection between corporate bonds, equities, and Treasury bonds through a Merton model with stochastic interest rates. We construct empirical measures of bond volatility using bond returns over daily, weekly, and monthly horizons. The empirical bond volatility is significantly larger than model-implied volatility, particularly when daily returns are used, suggesting liquidity as an explanation. Indeed, we find that variables known to be linked to bond liquidity are related to excess volatility in the cross-section. Finally, controlling for equity and Treasury exposures, we find a systematic component in bond residuals that gives rise to the excess volatility.

Department dc:contributor.department

Sloan School of Management.

Grantor dc:publisher

Massachusetts Institute of Technology

Year dc:date.issued

2009

Author dc:creator

• Bao, Jack (Jack C.)

Advisor dc:contributor.advisor

• Jun Pan.

• Sloan School of Management.

Statement dc:rights

• M.I.T. theses are protected by copyright. They may be viewed from this source for any purpose, but reproduction or distribution in any format is prohibited without written permission. See provided URL for inquiries about permission.

Licence dc:rights.uri

• http://dspace.mit.edu/handle/1721.1/7582

Language dc:language.iso

eng

Handle dc:identifier.uri

http://hdl.handle.net/1721.1/57870

OAI identifier oai:identifier

oai:dspace.mit.edu:1721.1/57870