 Valuing convertible bonds and the option to exchange bonds for stockJohn D. Finnerty Journal of Corporate Finance, 2015, vol. 31, issue C, 91-115 Abstract: The value of a conventional convertible bond is the value of a straight bond plus the value of the option to exchange it for a specified number of shares of common stock. First, I develop a closed-form contingent-claims convertible bond valuation model that quantifies the value of the exchange option when the short-term riskless rate, the firm's credit spread, and its share price are stochastic. I model the firm's decision to force early conversion as a stopping time problem in which the firm forces conversion as soon as the conversion value reaches the forced conversion barrier. I empirically validate the model by comparing model and market prices for a sample of 148 corporate convertible bonds issued between 2006 and 2010. The average median and mean pricing errors are −0.18% and 0.21%, respectively, which are within the average bid–ask spread for convertible bonds during the sample period. I use the model to quantify the disruptive impact that the prohibition on short selling during the recent financial crisis had on convertible bond prices. Keywords: Valuation; Convertible bond; Exchange option; Stopping time; Empirical validation (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:31:y:2015:i:c:p:91-115 DOI: 10.1016/j.jcorpfin.2014.12.012 Access Statistics for this article Journal of Corporate Finance is currently edited by A. Poulsen and J. Netter More articles in Journal of Corporate Finance from Elsevier |
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