Valuing Euro rating-triggered step-up telecom bonds
We value rating-triggered step-up bonds with three methods: (i) the Jarrow, Lando and Turnbull (1997, JLT) framework, (ii) a similar framework using historical probabilities and (iii) as plain vanilla bonds. We find that the market seems to value single step-up bonds according to the JLT model, while it values multiple step-up bonds as plain vanilla bonds. Further, step-up feature market premiums are more volatile than JLT and historical premiums, and the JLT model approximates market premiums always better than the historical method. Finally, most step-up bonds offer a cushion against rating migrations via dampened price movements.
Houweling, P., Mentink, A.A., & Vorst, A.C.F.. (2003). Valuing Euro rating-triggered step-up telecom bonds (No. EI 2003-50). Retrieved from http://hdl.handle.net/1765/1082