On the Interest Rate Sensitivity of Corporate Securities

Abstract

We use contingent claim asset pricing and exploit capital structure priority to better understand the relation between corporate security returns and interest rate changes, i.e., duration. We show theoretically and confirm empirically that lower priority securities, such as subordinated debt and equity, have low or even negative durations because they are effectively short higher priority, high duration, fixed rate debt. This finding has important implications for interpreting (i) time-varying correlations between the stock market and government bonds, (ii) bond factors in pricing models and forecasting models for bond and stock returns, (iii) the Fisher effect, and (iv) the betas of corporate bonds.