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Duration, Default Risk, And The Term Structure Of Interest Rates

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  • Yan Alice Xie
  • Sheen Liu
  • Chunchi Wu

Abstract

We examine the interactive effect of default and interest rate risk on duration of defaultable bonds. We show that duration for defaultable bonds can be longer or shorter than default‐free bonds depending on the relation between default intensity and interest rates. Empirical evidence indicates that in most cases duration for defaultable bonds is much shorter than for their default‐free counterparts because of the negative relation between default risk and interest rates. Results suggest that the duration measure must be adjusted for the effects of default risk and stochastic interest rates to achieve an effective bond portfolio immunization.

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  • Yan Alice Xie & Sheen Liu & Chunchi Wu, 2005. "Duration, Default Risk, And The Term Structure Of Interest Rates," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 28(4), pages 539-554, December.
    • Handle: RePEc:bla:jfnres:v:28:y:2005:i:4:p:539-554
    DOI: 10.1111/j.1475-6803.2005.00138.x
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    Cited by:

    1. Xie, Yan Alice & Liu, Sheen & Wu, Chunchi & Anderson, Bing, 2009. "The effects of default and call risk on bond duration," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1700-1708, September.
    2. Lee, Hei Wai & Xie, Yan Alice & Yau, Jot, 2011. "The impact of sovereign risk on bond duration: Evidence from Asian sovereign bond markets," International Review of Economics & Finance, Elsevier, vol. 20(3), pages 441-451, June.

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