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Binomial Tree Model for Convertible Bond Pricing within Equity to Credit Risk Framework

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  • K. Milanov
  • O. Kounchev

Abstract

In the present paper we fill an essential gap in the Convertible Bonds pricing world by deriving a Binary Tree based model for valuation subject to credit risk. This model belongs to the framework known as Equity to Credit Risk. We show that this model converges in continuous time to the model developed by Ayache, Forsyth and Vetzal [2003]. To this end, both forms of credit risk modeling, the so-called reduced (constant intensity of default model for the underlying) and the so-called synthesis (variable intensity of default model for the underlying) are considered. We highlight and quantify certain issues that arise, as transition probability analysis and threshold values of model inputs (tree step, underlying stock price, etc.). This study may be considered as an alternative way to develop the price dynamics model of Ayache et al. [2003] for convertible bonds in credit risk environment.

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  • K. Milanov & O. Kounchev, 2012. "Binomial Tree Model for Convertible Bond Pricing within Equity to Credit Risk Framework," Papers 1206.1400, arXiv.org.
    • Handle: RePEc:arx:papers:1206.1400
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    References listed on IDEAS

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    1. Yuriy Zabolotnyuk & Robert Jones & Chris Veld, 2010. "An Empirical Comparison of Convertible Bond Valuation Models," Financial Management, Financial Management Association International, vol. 39(2), pages 675-706, June.
    2. Akihiko Takahashi & Takao Kobayashi & Naruhisa Nakagawa, 2001. "Pricing Convertible Bonds with Default Risk: A Duffie-Singleton Approach," CIRJE F-Series CIRJE-F-140, CIRJE, Faculty of Economics, University of Tokyo.
    3. Clark, Truman A & Weinstein, Mark I, 1983. "The Behavior of the Common Stock of Bankrupt Firms," Journal of Finance, American Finance Association, vol. 38(2), pages 489-504, May.
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    Cited by:

    1. Rakhymzhan Kazbek & Yogi Erlangga & Yerlan Amanbek & Dongming Wei, 2023. "Valuation of the Convertible Bonds under Penalty TF model using Finite Element Method," Papers 2301.10734, arXiv.org.

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