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Simulation-based pricing of convertible bonds

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  • Ammann, Manuel
  • Kind, Axel
  • Wilde, Christian

Abstract

We propose and empirically investigate 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.

Suggested Citation

  • Ammann, Manuel & Kind, Axel & Wilde, Christian, 2008. "Simulation-based pricing of convertible bonds," Journal of Empirical Finance, Elsevier, vol. 15(2), pages 310-331, March.
  • Handle: RePEc:eee:empfin:v:15:y:2008:i:2:p:310-331
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    Cited by:

    1. Markus Buergi, 2013. "Pricing contingent convertibles: a general framework for application in practice," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(1), pages 31-63, March.
    2. Jonathan A. Batten & Karren Lee-Hwei Khaw & Martin R. Young, 2014. "Convertible Bond Pricing Models," Journal of Economic Surveys, Wiley Blackwell, vol. 28(5), pages 775-803, December.
    3. Feng, Yun & Huang, Bing-hua & Huang, Yu, 2016. "Valuing resettable convertible bonds: Based on path decomposing," Finance Research Letters, Elsevier, vol. 19(C), pages 279-290.
    4. Kateryna Mishchenko & Volodymyr Mishchenko & Anatoliy Malyarenko, 2007. "Adapted Downhill Simplex Method for Pricing Convertible Bonds," Papers 0710.0241, arXiv.org.
    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. Tim Xiao, 2015. "Is the jump-diffusion model a good solution for credit risk modelling? The case of convertible bonds," Post-Print hal-01812928, HAL.
    7. repec:eee:reveco:v:49:y:2017:i:c:p:1-16 is not listed on IDEAS
    8. Tim Xiao, 2013. "A simple and precise method for pricing convertible bond with credit risk," Post-Print hal-01812927, HAL.
    9. Axel Kind, 2005. "Pricing American-Style Options By Simulation," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 19(1), pages 109-116, June.
    10. 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.
    11. Radha Krishn Coonjobeharry & Désiré Yannick Tangman & Muddun Bhuruth, 2016. "A Two-Factor Jump-Diffusion Model For Pricing Convertible Bonds With Default Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(06), pages 1-26, September.
    12. 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.
    13. 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.
    14. 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.
    15. 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 University Rotterdam.
    16. repec:eee:matcom:v:152:y:2018:i:c:p:35-50 is not listed on IDEAS
    17. 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.
    18. Feng, Yun & Huang, Bing-hua & Young, Martin & Zhou, Qi-yuan, 2015. "Decomposing and valuing convertible bonds: A new method based on exotic options," Economic Modelling, Elsevier, vol. 47(C), pages 193-206.

    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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