Research on convertible bond pricing efficiency based on nonparametric fixed effect panel data model

Abstract

Purpose – The purpose of this paper is to study the pricing efficiency of convertible bonds and arbitrage opportunities between the convertible bonds and the underlying stocks thus improve market efficiency. Design/methodology/approach – Using nonparametric fixed effect panel data model, the authors build pricing model of convertible bonds and obtain fitted value for them. Then the authors constructs simultaneous confidence band for the smooth function to identify mispricing and study the pricing efficiency and arbitrage opportunities of convertible bonds. Findings – Result shows, convertible bonds’ prices largely depend on stock prices. Pricing efficiency does not improve during the past few years as there are quite a few trading opportunities. Arbitrage opportunities increase as the stock prices approach it maxima, and selling opportunities for convertible bonds surpass buying opportunities which indicates that investors use market neutral strategies to arbitrage. Pricing efficiencies varies a lot and it is affected by the features of the stocks and convertible bonds. Index stocks eligible for margin trading with high liquidity enjoy higher pricing efficiency. Research limitations/implications – The study does not take into account trading cost and risk management measures. Practical/implications – Arbitrage between the underlying and the convertible bonds is profitable and contributes to pricing efficiency therefore should be encouraged. The regulator should pay attention to the extreme mispricing of the underlying and convertible bonds which cannot be corrected by the market as there might be manipulation. Originality/value – Since traditional pricing methods are based on the framework of non-arbitrage equilibrium with the assumption of balanced and perfect market, there are many restrictions in the pricing process and the practical utility is somewhat limited, and the impractical assumptions lead to model risk. This study uses nonparametric regression to study the pricing of convertible bonds thus circumvents the problem of model risk. Simultaneous confidence band for smooth function identifies mispricing and explicitly reflects the variation of pricing efficiency as well as signalizes trading opportunities. Application of nonparametric regression and simultaneous confidence band in derivative pricing is advantageous in accuracy and simplicity.

Application of Nonarbitrage Pricing Model and Finite Element Numerical Solution in the Value of Convertible Bonds in the Stock Market

“…In order to further verify the actual effect of the pricing model in this paper, a number of practical examples including the comparative analysis of the market price and theoretical price of convertible bonds, comparative experiment of the prediction effect between this model and the binary tree model, and analysis of the relative price error of convertible bonds are given. Through the analysis of experimental data, we can see that the calculation results of this pricing model are more accurate than the traditional binary tree model, and the calculated results are more in line with the actual market value [1][2][3].…”

Gold-oil-exchange rate volatility, Bombay stock exchange and global financial contagion 2008: Application of NARDL model with dynamic multipliers for evidences beyond symmetry

“…Another theoretical contribution is added to existing literature that there is the asymmetrical or nonlinear association between variables which are assumed to be linear by (Sahu et al, 2014;Shiva & Sethi, 2015;Tehreem, 2018;Keswani & Wadhwa, 2018;Neveen, 2018;Rajesh, 2019). Moreover, in existing literature few researchers have utilized arbitrage pricing theory to explain symmetrical connotations between macroeconomic fluctuations and stock indexes (Christofi et al, 1993;Günsel et al, 2009;Mollick & Nguyen, 2015;Saumya, 2012;Shahzad et al, 2017;Yan & Yang, 2016) while others have utilized EMH (Wickremasinghe, 2011;Hatemi-J, 2012;Singhania & Prakash, 2014;Othman et al, 2019). This research article has validated the arbitrage pricing theory and refuted a semi-strong version of an efficient market hypothesis by establishing an association between gold prices, oil prices, and currency value fluctuations but in a nonlinear way.…”

“…In the existing literature, some of the researchers have utilized the arbitrage pricing model (Christofi et al, 1993;Günsel et al, 2009;Mollick & Nguyen, 2015;Saumya, 2012;Yan & Yang, 2016), while other have utilized efficient market hypothesis as an underpinning theoretical model in order to explore symmetrical and asymmetrical linkages between Gold-Oil-Exchange rates and stock indexes (Floros & Vougas, 2008;Hatemi-J, 2012;Singhania & Prakash, 2014;Wickremasinghe, 2011). To the best of our knowledge, this is the first research article which is intended to answer the research question about the asymmetrical impact of international oil prices, gold prices, and exchange rate fluctuations on the Bombay stock exchange before and after the international economic recession of 2008 and over the entire duration from April 2003 to May 2020.…”

Impact analysis of US quantitative easing policy on emerging markets

“…Another benefit of panel data model is effectiveness in solving estimated model bias for economic heterogeneity between variables by reducing the collinearity among them (Zhao et al, 2013). Using nonparametric FE panel data model, Yan et al (2016) build pricing model of convertible bonds to obtain fitted value. Konstantakis et al (2014) use panel data model for the main sectors of economic activity in the USA over the period 1957-2006, just before the first signs of the USA and global recession made their appearance.…”