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The Price Elasticity of Discounted Bonds: Some Empirical Evidence

Published online by Cambridge University Press:  06 April 2009

Michael D. Joehnk ,
H. Russell Fogler  and
Charles E. Bradley
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Extract

It is widely accepted that percentage price changes in lower coupon (“deep discount”) bonds will exceed those of issues with higher coupons [see, e. g., 8 and 9 ]. Cramer and Hawk's recent article in this journal [5], in fact, utilized this assumption although no exact empirical verification was sought. In an efficient market, the existence of such capital gains opportunities would be expected to attract investors and thereby reduce any risk-adjusted advantage to these bonds. Indeed, Conard and Frankena found that exactly this riskadjustment phenomenon seems to occur [4, pp. 162–163]. Thus, the purpose of this note is to address the question: Have the deepest discount bonds actually provided the greatest capital gains opportunities during periods of falling interest rates? In doing so, the paper does not question the validity of the mathematical “linkage” between price and coupon; rather, it seeks to determine if market structure (e. g., investor preferences) leads to a breakdown in the assumed (traditional) price volatility-coupon level relationship.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 13 , Issue 3 , September 1978 , pp. 559 - 566
Copyright
Copyright © School of Business Administration, University of Washington 1978

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References

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