DETERMINANTS OF THE CALL OPTION ON CORPORATE-BONDS

A number of hypotheses have been proposed as explanations of the call feature in corporate bonds. Using a large sample of callable and noncallable corporate bonds issued during the period 1977-1986, this paper simultaneously examines the empirical validity of five hypotheses that have been offered to explain the call option. The evidence provides no support for the hypotheses that the call option provides managerial flexibility or tax advantages. There is mixed support for agency cost explanations of the corporate call feature. The call feature is found to be highly correlated with the level of interest rates and the maturity of debt issues. That is, the call feature is found to be more likely during periods of higher interest rates and for longer maturity bonds.