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Convertible Bond Underpricing: Renegotiable Covenants, Seasoning and Convergence

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Author Info
Alex W.H. Chan (School of Economics and Finance, University of Hong Kong)
Nai-fu Chen (Center for Advanced Research Finance, University of Tokyo)
Abstract

We investigate the long-standing puzzle on the underpricings of convertible bonds. We hypothesize that the observed underpricing is induced by the possibility that a convertible bond might renegotiate on some of its covenants, e.g., an imbedded put option, in financial difficulties. Consistent with our hypothesis, we find that the initial underpricing is larger for lower rated bonds. The underpricing worsens if the issuer experiences subsequent financial difficulties. However, conditional on no rating downgrades, our main empirical result shows that convertible bond prices do converge to their theoretical prices within two years. This seasoning period is shorter for higher rated convertible bonds.

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Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-437.

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Length: 61pages
Date of creation: Oct 2006
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Handle: RePEc:tky:fseres:2006cf437

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  4. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-25, July. [Downloadable!] (restricted)
  5. Rosengren, Eric S, 1993. " Defaults of Original Issue High-Yield Convertible Bonds," Journal of Finance, American Finance Association, vol. 48(1), pages 345-62, March. [Downloadable!] (restricted)
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  6. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May. [Downloadable!] (restricted)
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  7. Brennan, Michael J. & Schwartz, Eduardo S., 1980. "Analyzing Convertible Bonds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(04), pages 907-929, November. [Downloadable!]
  8. Ramaswamy, Krishna & Sundaresan, Suresh M., 1986. "The valuation of floating-rate instruments : Theory and evidence," Journal of Financial Economics, Elsevier, vol. 17(2), pages 251-272, December. [Downloadable!] (restricted)
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  10. Ammann, Manuel & Kind, Axel & Wilde, Christian, 2003. "Are convertible bonds underpriced? An analysis of the French market," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 635-653, April. [Downloadable!] (restricted)
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