Call and default can potentially alter the timing and amounts of promised cashflows for callable, corporate bonds. While prior research has indicated the theoretical importance of adjusting Macaulay duration for the impacts of default and call, the question of their relative impact remains a matter of debate [The High Yield Debt Market, Dow Jones Irwin, New York, 1990, p. 18; J. Finan. 53 (1998) 2225]. We develop a theoretical analysis incorporating both default and call effects on duration and test its implications employing a previously unexplored data base of Canadian, investment grade, corporate bond indices containing an unusual provision making it possible to identify callable and noncallable indices.

Recent evidence demonstrates that corporate payout policy has shifted from the nearly exclusive use of dividend payout to the inclusion of stock repurchase, primarily through open markets. This trend has been attributed to the tax advantages associated with repurchase relative to dividends. In this paper, we introduce personal taxation and stock repurchase to reexamine the relation between returns and the bid–ask spread. Our model provides insight into the nature of this relation. Tests performed using NYSE, AMEX, and NASDAQ data provide empirical support of our theoretical conclusions. We conclude that the firm’s choice of payout policy influences the relation between returns and spreads.

Abstract What drives the compensation demanded by investors in risky bonds? Longstaff and Schwartz (1995) predict that one key factor is the time-varying negative correlation between interest rates and the yield spreads on corporate bonds. However, the effects of callability and taxes also need to be considered in empirical analyses. Canadian bonds have no tax effects, yet, after controlling for callability, the correlation between riskless interest rates and corporate bond spreads remains negligible. Our results provide support for reduced-form models that explicitly define a default hazard process and untie the relation between the firm’s asset value and default probability.