The pricing of corporate bonds and determinants of financial structure

Abstract: This thesis contain three chapters.Default Risk in Corporate Bond Pricing. This chapter provides a model for how the corporate bond default risk influences the systematic risk and an empirical analysis of the systematic and idiosyncratic parts of U.S. corporate bond returns during 2001-2005. The average corporate bond beta is low and positive (0.06). Investment grade bonds have negative betas (between - 0.01 and -0.13) and non-investment grade bonds have positive betas (between 0.11 and 1.48), but both groups have similar within groups systematic risks. When controls for interest rate and liquidity risks are introduced there are still remaining default probabilities, implying that the default risk is in part systematic and in part idiosyncratic. Returns to Defaulted Corporate Bonds. In the second chapter short term excess returns in a sample of 279 defaulted US corporate bonds are tested for using multiple regression analysis. There are robust excess returns after controlling for market and liquidity risk. The expected recovery rate during 2001-2006 is estimated to be, on average, four percentage points lower the first month after default than the present value of the recovery rate after nine months.Capital Structure Choices. The trade-off and pecking order theories are tested using both established tests from the literature and new tests. The main contributions of this chapter are the new tests of financing of operating net assets (for the pecking order theory), the mean reversion tests (for the trade-off theory) and the test of mean reversion and trends. These tests allow for extended conclusions on the validity of the pecking order versus the tradeoff theory.