• A Simple and Precise Method for Pricing Convertible Bond with Credit Risk

    Author(s):
    Tim Xiao (see profile)
    Date:
    2014
    Group(s):
    Business Management, Scholarly Communication
    Subject(s):
    Values--Philosophy, Finance, Sociology, Economics
    Item Type:
    Article
    Tag(s):
    hybrid financial instrument, convertible bond, convertible underpricing, convertible arbitrage, default time approach, Value theory, Sociology of finance
    Permanent URL:
    http://dx.doi.org/10.17613/pzx4-am55
    Abstract:
    This paper presents a new model for valuing hybrid defaultable financial instruments, such as, convertible bonds. In contrast to previous studies, the model relies on the probability distribution of a default jump rather than the default jump itself, as the default jump is usually inaccessible. As such, the model can back out the market prices of convertible bonds. A prevailing belief in the market is that convertible arbitrage is mainly due to convertible underpricing. Empirically, however, we do not find evidence supporting the underpricing hypothesis. Instead, we find that convertibles have relatively large positive gammas. As a typical convertible arbitrage strategy employs delta-neutral hedging, a large positive gamma can make the portfolio highly profitable, especially for a large movement in the underlying stock price.
    Metadata:
    xml
    Published as:
    Journal article     Show details
    Pub. DOI:
    https://doi.org/10.1057/jdhf.2014.5
    Publisher:
    Palgrave Macmillan UK
    Pub. Date:
    20 February 2014
    Journal:
    Journal of Derivatives & Hedge Funds
    Volume:
    19
    Issue:
    4
    Page Range:
    259 - 277
    ISSN:
    1753-965X
    Status:
    Published
    Last Updated:
    4 years ago
    License:
    All-Rights-Granted

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