Journal of Corporate Finance Vol. 31 2015
Valuing convertible bonds and the option to exchange bonds for stock
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.
- DOI
- 10.1016/j.jcorpfin.2014.12.012
- Volume
- 31
- Pages
- 91-115
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref