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

Tim Xiao
2020 Figshare  
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
more » ... ically, 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. https://figshare.com/articles/A_Simple_and_Precise_Method_for_Pricing_Convertible_Bond_with_Credit_Risk/8292215/files/22984094.pdf
doi:10.6084/m9.figshare.8292215.v2 fatcat:ckxahat3urbzjnq6icbck6gcom