A Pure Test for the Elasticity of Yield Spreads

instrument for the isolation of the effect of default risk and its significance.

This result allows us to control for callability for the long-term BBB-rated SCM bond
index, during the later period of our 25-year sample. To determine the duration of this period,
for each month during the 01:1993-12:1999 7-year period we count the number of corporate
bonds issued with a doomsday call provision, the number of bonds issued with a standard
call provision, and the number of noncallable bonds, as reported in the Financial Post
Corporate Bond Record. In Figure 2 we plot the proportion of each of the above categories
calculated with respect to the total number of bonds within each month. As most Canadian
corporate bonds issued after 1986 either are noncallable or carry a doomsday call, in Figure
2 we see that the proportion of doomsday-call bonds increases considerably during the 7-
year period, from 22.82 percent in 01:1993 to 47.48 percent in 12:1999. At the same time,
the proportion of bonds carrying a standard call provision decreases dramatically, from 41.03
percent in 01:1993 to 8.25 percent in 12:1999. The proportion of noncallable bonds
fluctuates between 34.46 percent and 47.29 percent.

***Insert Figure 2 here***

The above proportions are calculated for the entire Canadian corporate bond universe as
covered by the Financial Post Corporate Bond Record. One can expect the proportion of
long-term doomsday bonds, with over ten years to maturity, to be much higher compared to
that of medium-term and short-term bonds. Since most Canadian corporate bonds are issued
with 10 to 20 years to maturity, it is more likely that the number of newly issued short-term
and mid-term bonds in SCM's mid-term and short-term indices is dominated by the number
of seasoned bonds. Thus, for those indices, it is more likely that most bonds are those
originally issued prior to 1987 with the standard call provision.

CANSIM reports that as of 01:1987, the weighted average maturity for SCM's long-
term AA, A, and BBB indices, is 14.61 years, 14.80 years, and 13.34 years, respectively.

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