Valuation and optimal strategies of convertible bonds

Abstract

This article presents a contingent claim valuation of a callable convertible bond with the issuer's credit risk. The optimal call, voluntary conversion, and bankruptcy strategies are jointly determined by shareholders and bondholders to maximize the equity value and the bond value, respectively. This model not only incorporates tax benefits, bankruptcy costs, refunding costs, and a call notice period, but also takes account of the issuer's debt size and structure. The numerical results show that the predicted optimal call policies are generally consistent with recent empirical findings; therefore, calling convertible bonds too late or too early can be rational. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:895-922, 2006 The authors are grateful to an anonymous reviewer for his/her valuable comments and suggestions.

Game option models of convertible bonds: Determinants of call policies

“…Brennan and Schwartz (1977) consider more generalized contingent claims models of convertibles and present finite difference solution of the pricing models. Liao and Huang (2006) present enhanced versions of the firm value contingent claims models with the incorporation of various structural features, like tax benefits, bankruptcy costs, refunding costs, call notice period, etc. In the first generation of contingent claims models, the firm value process is used as the stochastic fundamental and the corporate structure of the issuer firm is assumed to have senior straight debt, convertible bond and equity.…”

Analyzing interactive call, default, and conversion policies for corporate bonds

“…A detailed review of convertible bond financing can be found in Dutordoir et al (2014). 4 The structural credit-risk model is widely adopted for pricing convertible bonds, such as Sîrbu and Shreve (2006), Liao and Huang (2006), and N. Chen et al (2013), to name a few. Though pricing convertibles with default risk can also be handled via Jarrow and Turnbull's (1995) reducedform credit-risk model, such as Chambers and Lu (2007) and Wang and Dai (2017), adopting structural models facilitates the analyses of option exercise policies in terms of the bond issuer's asset value and interest rate.…”

“…Likewise, a typical minimum call notice period in a callable convertible bond is 30 days, and the maximum length of this period reaches 92 days in King and Mauer's (2014) sample. Liao and Huang (2006) incorporate this feature into their CVCD evaluation framework.…”

Pricing Warrant Bonds with Credit Risk under a Jump Diffusion Process

“…Liao and Huang [3] considered the pricing of convertible bond with credit risk under the geometric Brownian motion model. Zhou and Wang [4] assumed that the interest rate follows the geometric Brownian motion and obtained the valuation of convertible bond by the method of measure transformation.…”