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Pricing convertible bonds

Author

Listed:
  • Batten, Jonathan A.
  • Khaw, Karren Lee-Hwei
  • Young, Martin R.

Abstract

Convertible bonds are an important segment of the corporate bond market although their pricing is compromised by the presence of complex option features and difficulty in measuring the risk factors needed as inputs to standard valuation models. Using a unique sample of pure U.S. convertible bonds, devoid of other optionality, we show that underpricing is affected mainly by the degree of underlying asset volatility and liquidity. Convertible bonds with a greater debt component (more credit sensitive), longer time to maturity and lower quality credit ratings are also found to be more underpriced. The global financial crisis (GFC) is an episode with high-underlying asset volatility and one subject to short-selling constraints. During this period there was deep convertible bond discounting, which highlights the importance of market conditions and the temporal, rather than systematic, nature of the pricing errors.

Suggested Citation

  • Batten, Jonathan A. & Khaw, Karren Lee-Hwei & Young, Martin R., 2018. "Pricing convertible bonds," Journal of Banking & Finance, Elsevier, vol. 92(C), pages 216-236.
    • Handle: RePEc:eee:jbfina:v:92:y:2018:i:c:p:216-236
    DOI: 10.1016/j.jbankfin.2018.05.006
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    Citations

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    Cited by:

    1. Peter J. Zeitsch, 2024. "Convertible Bond Arbitrage Smart Beta," Computational Economics, Springer;Society for Computational Economics, vol. 63(1), pages 159-192, January.
    2. Marie-Claude Vachon & Anne Mackay, 2024. "A Unifying Approach for the Pricing of Debt Securities," Papers 2403.06303, arXiv.org.
    3. Kim, Byung-June & Jang, Bong-Gyu, 2021. "Convertible bond valuation with regime switching," Chaos, Solitons & Fractals, Elsevier, vol. 150(C).
    4. Xiaoyu Tan & Zili Zhang & Xuejun Zhao & Shuyi Wang, 2022. "DeepPricing: pricing convertible bonds based on financial time-series generative adversarial networks," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 8(1), pages 1-38, December.
    5. Liao, Yulu & Huang, Paoyu & Ni, Yensen, 2022. "Convertible bond issuance volume, capital structure, and firm value," The North American Journal of Economics and Finance, Elsevier, vol. 60(C).
    6. Liang‐Chih Liu & Tian‐Shyr Dai & Lei Zhou & Hao‐Han Chang, 2022. "Analyzing interactive call, default, and conversion policies for corporate bonds," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(8), pages 1597-1638, August.
    7. Juan David González-Ruiz & Maria Isabel Acosta-García & Ramón Villa-García, 2021. "Financial Behaviour in a Mandatory Conversion Process: Empirical Evidence from Colombia," Global Business Review, International Management Institute, vol. 22(1), pages 69-84, February.
    8. Tian‐Shyr Dai & Chen‐Chiang Fan & Liang‐Chih Liu & Chuan‐Ju Wang & Jr‐Yan Wang, 2022. "A stochastic‐volatility equity‐price tree for pricing convertible bonds with endogenous firm values and default risks determined by the first‐passage default model," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(12), pages 2103-2134, December.
    9. Ling, Yu-Xiu & Xie, Chi & Wang, Gang-Jin, 2022. "Interconnectedness between convertible bonds and underlying stocks in the Chinese capital market: A multilayer network perspective," Emerging Markets Review, Elsevier, vol. 52(C).

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