Optimal Call Policy for Corporate Bonds

Francis A. Longstaff and Bruce Tuckman

University of California at Los Angeles, Anderson Graduate School of Management from Anderson Graduate School of Management, UCLA

Abstract: It is widely believed that it is optimal to call a bond as soon as its market price equals its call price. We show that this policy is generally not optimal when there is more than one bond issue outstanding because minimizing the value of a particular bond issue is not the same as maximizing the value of equity. Furthermore, the value of a callable bond can rationally exceed the call price when a firm follows the optimal call policy. These results have important implications for valuing and hedging callable bonds.

Date: 1993-08-01
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