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Simulation-Based Pricing of Convertible Bonds

  • Manuel Ammann

    (University of St. Gallen)

  • Axel Kind

    (University of St. Gallen)

  • Christian Wilde

    (Johann Wolfgang Goethe University Frankfurt)

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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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
Contact details of provider: Web page: http://econwpa.repec.org

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  9. 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.
  10. Barone-Adesi, Giovanni & Bermudez, Ana & Hatgioannides, John, 2003. "Two-factor convertible bonds valuation using the method of characteristics/finite elements," Journal of Economic Dynamics and Control, Elsevier, vol. 27(10), pages 1801-1831, August.
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