Default Risk and the Duration of Zero Coupon Bonds

Abstract

ABSTRACT This paper applies a contingent claims approach to examine the duration of a zero coupon bond subject to default risk. One replicating portfolio for a default‐prone zero coupon bond contains a long position in the default‐free asset plus a short position in a put option on the underlying assets. The duration of the bond is shown to be a weighted combination of the duration of the default‐free bond and the put option. The duration is less than maturity and is not an immunizing duration. The technique is then extended to subordinated debt.

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