BOND REFUNDING IN EFFICIENT MARKETS: A DYNAMIC ANALYSIS WITH TAX EFFECTS

This paper provides a dynamic analysis of the bond refunding problem in an efficient market setting with corporate taxes and transaction costs. A new methodology is developed to analyze the optimal exercise problem in the presence of imperfections. This analysis enables prediction of the effect of changes in corporate tax laws on the refunding decision. It also explains the empirical observation that bonds are often called when the bond price is below the call price.