OPTIMAL BOND CALL POLICIES UNDER TRANSACTIONS COSTS

In this paper I analyze the effects of refunding transactions costs on the firm's optimal call policy. Refunding transactions costs cause the firm to delay calling a bond when its market value first reaches the call price. This effect causes the price path of a callable bond to be a locally concave function of the interest rate, reaching a maximum price above the call price. Comparative static results show that the magnitude of the premium above the call price is an increasing function of transactions costs. An empirical test on a sample of nonconvertible bonds supports the model's transactions costs prediction.