An Empirical Comparison of Convertible Bond Valuation Models

Abstract

An Empirical Comparison of Convertible Bond Valuation ModelsThis paper empirically compares three convertible bond valuation models. We use an innovative approach where all model parameters are estimated by the Marquardt (1963) algorithm using a subsample of convertible bond prices. The model parameters are then used for out-of-sample forecasts of convertible bond prices. The mean absolute deviation is 1.86% for the Ayache-Forsyth-Vetzal (2003)

Do Convertible Bond Issuers Cater to Investor Demand?

“…The Tsiveriotis and Fernandes (1998) model is widely used in other academic studies that examine convertible bond underpricing (Ammann, Kind, and Wilde, 2003; Chan and Chen, 2007; Loncarski et al, 2009; de Jong et al, 2011). Zabolotnyuk, Jones, and Veld (2010) point out that the method is also popular among practitioners. provides a detailed discussion of our calculation of the theoretical convertible bond price.…”

“…Delta has the advantage that it incorporates several convertible bond design parameters, thus offering a comprehensive measure of the convertible debt equity component size. However, Delta does not take into account convertible bond callability (Lewis et al, 1998; Zabolotnyuk et al, 2010). Moreover, it is partially dependent upon factors that are not (entirely) under the control of the issuing firm, such as risk‐free interest rates and the issuer's stock return volatility.…”

Do Convertible Bond Issuers Cater to Investor Demand?

“…The Tsiveriotis and Fernandes (1998) model is widely used in other academic studies that examine convertible bond underpricing (Ammann, Kind, and Wilde, 2003;Chan and Chen, 2007;Loncarski et al, 2009;de Jong et al, 2011). Zabolotnyuk, Jones, and Veld (2010) point out that the method is also popular among practitioners. Appendix A provides a detailed discussion of our calculation of the theoretical convertible bond price.…”

Convertible Bond Pricing Models

“…Further analysis reveals that OTM convertible bonds tend to be underpriced whereas ITM convertible bonds are more likely to be overpriced (Ammann et al ., ; Carayannopoulos and Kalimipalli, ; Zabolotnyuk et al ., ), which is similar to the structural approach. Reasonably, an OTM convertible bond is less attractive for an investor, thus reducing its price.…”

“…A recent paper by Zabolotnyuk et al (2010) compares the efficiency of three pricing models by Brennan and Schwartz, (1980), Tsiveriotis andFernandes, (1998), andAyache et al (2003) respectively. These models each treat credit risk differently.…”