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Simulation-Based Pricing of Convertible Bonds

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Author Info

  • Manuel Ammann

    (University of St. Gallen)

  • Axel Kind

    (University of St. Gallen)

  • Christian Wilde

    (Johann Wolfgang Goethe University Frankfurt)

Abstract

We propose and empirically study a pricing model for convertible bonds based on Monte Carlo simulation. The method uses parametric representations of the early exercise decisions and consists of two stages. Pricing convertible bonds with the proposed Monte Carlo approach allows us to better capture both the dynamics of the underlying state variables and the rich set of real-world convertible bond specifications. Furthermore, using the simulation model proposed, we present an empirical pricing study of the US market, using 32 convertible bonds and 69 months of daily market prices. Our results do not confirm the evidence of previous studies that market prices of convertible bonds are on average lower than prices generated by a theoretical model. Similarly, our study is not supportive of a strong positive relationship between moneyness and mean pricing error, as argued in the literature.

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File URL: http://128.118.178.162/eps/fin/papers/0507/0507015.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0507015.

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Length: 42 pages
Date of creation: 16 Jul 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0507015

Note: Type of Document - pdf; pages: 42
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Web page: http://128.118.178.162

Related research

Keywords: Convertible bonds; Pricing; American Options; Monte Carlo simulation;

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References

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Citations

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Cited by:
  1. Dutordoir, Marie & Van de Gucht, Linda, 2007. "Are there windows of opportunity for convertible debt issuance? Evidence for Western Europe," Journal of Banking & Finance, Elsevier, vol. 31(9), pages 2828-2846, September.
  2. Ammann, Manuel & Kind, Axel & Seiz, Ralf, 2010. "What drives the performance of convertible-bond funds?," Journal of Banking & Finance, Elsevier, vol. 34(11), pages 2600-2613, November.
  3. Dutordoir, M.D.R.P. & van de Gucht, L., 2006. "Are There Windows of Opportunity for Convertible Debt Issuance? Evidence for Western Europe," ERIM Report Series Research in Management ERS-2006-055-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
  4. Xiao, Tim, 2013. "Is the Jump-Diffusion Model a Good Solution for Credit Risk Modeling? The Case of Convertible Bonds," MPRA Paper 47366, University Library of Munich, Germany.
  5. Xiao, Tim, 2014. "A Simple and Precise Method for Pricing Convertible Bond with Credit Risk," MPRA Paper 53982, University Library of Munich, Germany.
  6. Siddiqi, Mazhar A., 2009. "Investigating the effectiveness of convertible bonds in reducing agency costs: A Monte-Carlo approach," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(4), pages 1360-1370, November.
  7. Markus Buergi, 2013. "Pricing contingent convertibles: a general framework for application in practice," Financial Markets and Portfolio Management, Springer, vol. 27(1), pages 31-63, March.
  8. Axel Kind, 2005. "Pricing American-Style Options By Simulation," Financial Markets and Portfolio Management, Springer, vol. 19(1), pages 109-116, June.
  9. Xu, Ruxing, 2011. "A lattice approach for pricing convertible bond asset swaps with market risk and counterparty risk," Economic Modelling, Elsevier, vol. 28(5), pages 2143-2153, September.
  10. Kateryna Mishchenko & Volodymyr Mishchenko & Anatoliy Malyarenko, 2007. "Adapted Downhill Simplex Method for Pricing Convertible Bonds," Papers 0710.0241, arXiv.org.

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