Risk Management and Agency Theory: Role of the Put Option in Corporate Bonds
Round 1
Reviewer 1 Report
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Comments for author File: 
Comments.pdf
Author Response
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Author Response File: 
Author Response.docx
Reviewer 2 Report
In the attached document, you can find my comments.
Comments for author File: Comments.docx
Author Response
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Author Response File: Author Response.docx
Reviewer 3 Report
I am pleased to have the opportunity to review this research paper. This study attempted to explore the Risk Management and Agency Theory: Role of the Put Option in Corporate Bonds. Although the topic of this research study is interesting and fits within the journal scope, I think authors should apply the comments indicated below to increase the quality of research justification, contributions and findings. The manuscript know lacks in scientific style and structure.
First of all, paper research gap. Please improve this part in introduction section. Introduction is very general and lacked alignment to the research findings, no discussion was provided to derive the implication from. Theoretical and pragmatics implication are vague and need to be better aligned with this paper theoretical underpinnings and proposed process. Furthermore, there is insufficient support and weak arguments in support of the objective that is proposed as well as the model developed. In the final part of the introduction the objectives proposed, originality and gap that would be better covered. Also how the author will perform the methodology.
the topic of this research study is interesting and fits within the journal scope, I think authors should apply the comments indicated to increase the quality of research justification, contributions and findings
What is the originality of this research? Paper research gap and originality should be better presented at the end of introduction section
Please consider this structure for manuscript final part.
-Discussion
-Conclusion
-Managerial Implication
-Practical/Social Implications
-Discussion needs to be a coherent and cohesive set of arguments that take us beyond this study in particular, and help us see the relevance of what authors have proposed. Authors should create an independent “Discussion” section. Author need to contextualize the findings in the literature, and need to be explicit about the added value of your study towards that literature. Also other studies should be cited to increase the theoretical background of each of the method used. Findings should be contextualized in the literature and should be explicit about the added value of the study towards the literature. Limitations and future research
Questions to be answered:
What practical/professional and academic consequences will this study have for the future of scientific literature (theoretical contributions)?
Why is this study necessary? should make clear arguments to explain what is the originality and value of the proposed model. This should be stated in the final paragraphs of introduction and conclusion sections.
Author Response
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Author Response File: Author Response.docx
Round 2
Reviewer 1 Report
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Comments for author File: Comments.pdf
Author Response
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Author Response File: Author Response.pdf
Reviewer 2 Report
Good job dear authors.
Author Response
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Author Response File: Author Response.pdf
Reviewer 3 Report
Congratulations, your work is now better. I only ask you to support with literature the need for your study before it is published.
Round 3
Reviewer 1 Report
A file with the report is attached.
Comments for author File: Comments.pdf
This manuscript is a resubmission of an earlier submission. The following is a list of the peer review reports and author responses from that submission.
Round 1
Reviewer 1 Report
The paper studies the impact of a put feature in the risk management of fixed rate bonds. My impression in negative. Below are the main reasons.
- The model is not clearly specified. I read in introduction that "Delta is the first derivative of the bond's value with respect to the firm's value, and measures the sensitivity to credit risk" and that makes no sense to me. In fixed income modeling, Delta is the sensitivity to the underlying interest rate and measures duration. If another approach is chosen, this has to be clearly explained (see below).
- The authors claim to use a "structural contingent claim valuation". Again, nothing is clearly explained here. I guess they are referring to the structural approach that, like in the Merton model for instance, sees the market value of the firm's assets V as the sum of its equity and of a zero coupon bond of a certain maturity (extension to coupon bonds can be made). In this case the equity value can bee seen as some call option over V, and its Delta can be seen as the sensitivity to the firm's asset value, but not to credit risk. Moreover, I do not see why Gamma should represent the "security's susceptibility to asset-substitution".
- The equations are VERY poorly written. Authors should use LaTex, or, at least, the equation mode in Word.
- In section 4 when it comes to parameter estimation, again, no details are provided. The authors claim to bound the volatility by the equity volatility (upper bound) from a positive correlation argument, which makes no sense to me. First, we are not sure that the firm has a traded equity, with a daily market price available. Second, if we assume that this market price exists, then the volatility of V can indeed be approximated by the equity volatility, but this is a very strong assumption which has no real economical justification. To calibrate the volatility properly, one generally uses an algorithm such as the one by Vassalou and Xing (2004) that allows to infer the volatility of the firms assets (which is not observable) from the volatility of its equity (which is observable).
- In the same vein, in the binomial algorithm for solving eq. 2, as V is not observable I do not see how the algorithm can be implemented. Again, assuming the call is European, one has a closed formula (Black-Scholes formula) which, combined to the Vassalou algorithm, allows to calibrate V when calibrating the volatility.
- Section 5: the authors recall the definition of the Greeks (Delta, Gamma etc) but do not explain how they are able to compute them in practice.
In conclusion and in regards to the issues raised above, I suggest to reject this manuscript.
Author Response
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Author Response File: Author Response.docx
Reviewer 2 Report
The paper covers an interesting and important topic of the basic features of the call derivatives such as the put or call attribute, in the perspective of both risk management and agency theories. The overall quality of the paper is high - the research methods were selected and applied correctly; the conlusions are grounded in the analysis. I have some minor comments.
- Both abstract and introduction should include more detailed overview of the aim of the paper and the research methods applied in the study.
- The aim of the study seems too vague - it should be more clear and linked to the paper's contribution.
- The final section should be expanded and include more in-depth discussion of the issues such as comparisons to the results of the previous studies, limitations of the analysis, directions for the future research and practical implications.
Author Response
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Author Response File: Author Response.docx
Reviewer 3 Report
A file with the report is attached.
Comments for author File: Comments.pdf
Author Response
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Author Response File: Author Response.docx
Round 2
Reviewer 1 Report
I have gone through the revised version of this manuscript. While I appreciate some efforts made by the author notably regarding the presentation of equations, my opinion has not significantly changed. Let me briefly comment on some of the authors'response:
1. " [..] Delta is clarified on lines 44-47 by drawing a parallel between Delta and distance-to-default. We have also changed the wording to reflect that Delta is a “proxy” for credit risk in the sense that if Delta is large then the bond has higher credit risk and if Delta is small then the bond has lower credit risk [...]" --> None of these makes sense. In credit risk modeling, distance to default (DD) has a very precise definition and has nothing to see with the Delta (let me just recall that, under the standard Black-Scholes-Merton notations, DD=d2 and Delta=N(d1)). My recommendation is to define objects precisely before trying to discuss them.
2. "[...]We have now clarified the model in reference to Merton (1974) in lines 37-39, and lines 260-280. We have now provided an expanded discussion on Gamma (convexity) on lines 47-53 and why it measures the bond’s susceptibility to asset-substitution [...]". "[...] We have also added a new argument relating convexity to distance to default on lines 54-56." --> Same remark than 1. applies regarding distance to default. Moreover the Merton model is not clearly specified; if, as the author claim in the manuscript, r is the risk-free rate, then it means that the model is specified under the risk neutral measure and calibration has to be made on derivatives (CDS etc.) to have a sense. If calibration is made on historical security prices, then the model has to be specified under the physical measure, and r (in this case, the actual drift) has to be estimated to.
4. "[...] The method to calculate the lower bound is provided on lines 432-436 and footnote (2) provides an alternate method to estimate the lower bound, which yields comparable results [...]" --> Nothing is proved here.
6. " [..] We have now added a new paragraph explaining how the Greeks are calculated in lines 498-509" --> I see no such explanation, except some extremely vague considerations about finite difference methods. Crucial details are missing about what finite difference estimator, e.g. what shift is chosen (up, down, central?), how the error is controlled etc.
As a conclusion, I still recommend to reject this submission.
Reviewer 3 Report
A file with the report on the revised version of the paper is attached.
Comments for author File: Comments.pdf
