market purchases, although the opportunities for distortions in pricing are evident.
In addition, credit spreads on corporate bonds may also be compromised by the ability
for some local firms to credit enhance their international as well as domestic debt through
the use of dedicated cash-flow from exports. Specifically, Durbin and Ng (2005) investigate
emerging markets for “sovereign ceiling effects,” which says that a firm is no more
creditworthy than its government. Contrary to expectations they find evidence which refutes
the presence of a sovereign ceiling, for local firms that have substantial export earnings
and/or a close relationship with either a foreign firm or government.
3.2 The Canadian Doomsday Call Provision
To control for callability, Duffee (1998) suggests stratifying data by forming two
portfolios for each rating category, one consisting of only callable bonds, and the other of
noncallable bonds. However, there may be a selection bias in callability related to risk
differences between callable and noncallable bonds. For example, Bodie and Taggart (1978)
claim that firms with more growth opportunities are more likely to issue callable bonds. If
the firm's expectations of growth are confirmed, its shareholders can avoid sharing this good
fortune with bondholders by simply having the firm's managers call the entire bond issue.
Berk, Green, and Naik (1999) show that the systematic risk of asset returns is related to the
firm's growth opportunities. This implies that stratifying bond data based on callability may
create two risk classes within each rating category.
Canadian corporate bonds have a feature that allows for mitigating the potential
selection bias associated with callability. Most Canadian corporate bonds issued from 1987,
carry a call provision called the “doomsday” call provision. This call provision makes it
possible to control for callability for some bonds, facilitating the study of a set of corporate
bonds broader than just noncallable bonds. Similar to the U.S. make-whole call option, a
doomsday call provision sets the call price at the maximum of the par value of the bond, or
the value of the bond calculated based on the yield on a Government of Canada bond (with a