series: TI 03-028/2
Valuing Euro Rating-Triggered Step-Up Telecom Bonds
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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.