Convertible Bond Underpricing: Renegotiable Covenants, Seasoning, and Convergence

Alex W. H. Chan () and Nai-fu Chen ()
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Alex W. H. Chan: School of Economics and Finance, The University of Hong Kong, Hong Kong
Nai-fu Chen: The Paul Merage School of Business, University of California, Irvine, California 92697

Management Science, 2007, vol. 53, issue 11, 1793-1814

Abstract: We investigate the long-standing puzzle on the underpricings of convertible bonds. We hypothesize that the observed underpricing is induced by the possibility that a convertible bond might renegotiate on some of its covenants, e.g., an imbedded put option in financial difficulties. Consistent with our hypothesis, we find that the initial underpricing is larger for lower rated bonds. The underpricing worsens if the issuer experiences subsequent financial difficulties. However, conditional on no rating downgrades, our main empirical result shows that convertible bond prices do converge to their theoretical prices within two years. This seasoning period is shorter for higher rated convertible bonds.

Keywords: finance; asset pricing; convertible bond; credit risk; valuation (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (20)

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