more important for lower-rated bonds. Given that the BBB index is the lowest-rated index in
our sample, one can expect the default factor, manifested by the interest-rate factor in
Longstaff and Schwartz (1995), to have the strongest impact on the yield spread - riskless
rate relation estimated for this index.
Panel B of Table 2 reports our results for the 01:1995-07:2001 period. Our estimated
coefficients b for the BBB index is statistically insignificant.11 This result implies no relation
between credit spreads and the riskless rate for the economically noncallable corporate bonds
rated BBB. This result indicates that the default factor, which represents Longstaff and
Schwartz's interest-rate factor, is trivial for BBB-rated bonds, for which it is expected to be
most important within our sample. Contrasting these results with those reported in Panel A of
Table 2 for the same index, it becomes clear that what drives the negative sign of b is the
negative impact of the callability factor.
In Figure 1 we show that the probability of a call for the doomsday call provision in
the AA- and A-rated indices is significant. Thus, one should expect the doomsday call for
these indices to induce a negative yield spread - riskless rate relation, as in the case of bonds
carrying the standard call provision.12 This negative relation is confirmed by the results
reported in Panel B of Table 2. Our estimated coefficients b are negative and statistically
significant for the economically callable AA- and A-rated indices during the 01:1995-
07:2001 estimation period.
Figure 1 also demonstrates that the probability of a call is significantly higher for AA-
rated bonds compared with A-rated bonds. Thus, one may expect the negative impact of the
callability term on the sign of b to be greater for the AA index than for the A index. The
results reported in Panel B of Table 2 support this hypothesis. Above, we saw that for the
entire 25-year sample period the estimated coefficient b monotonically decreases with credit
quality. For the 01:1995-07:2001 period this monotonicity is reversed in line with the
moneyness of the doomsday call.
Finally, the estimates for the coefficient c for the 01:1995-07:2001 period in Panel B of
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