Risk-Free Interest Rates, the Call Feature, and Corporate Bond Yield Spreads

This paper provides an explanation for the negative relation between corporate bond yield spreads and risk-free interest rates, documented by Longstaff & Schwartz (1995) and Duffee (1998). The model also explains the effects of the call feature and bond risk (or rating) on the yield spread-interest rate relationship; it shows that (i) the call feature should generally strengthen the negative relationship, but should weaken it for low-grade …