An Empirical Analysis Of Chinese Convertible Bonds Pricing With Exogenous Credit Risk

With the development and perfection of the capital market in China, convertible bond (CB), which is the familiar financing mode in the western developed countries, is gradually accepted and used. It not only exploits the financing channel of enterprises and extends the modes of market investment, but also is important to flourish and promote the development of securities market. Based on Western convertible bonds pricing theory, we use limited difference pricing model and find some pricing rules of CB in our market after considering the complex specifications of CB. Comparing with previous studies, we take CB's credit risk into account. For those CBs whose underlying stock prices are higher than their conversion prices, as a company is always able to deliver its own stock, the CB is risk free and we discount it with risk-free interest rate. For those CBs whose underlying stock prices are lower than their conversion prices, we discount the CB with a risk-adjusted rate which is composed by the risk-free interest rate and a safety premium. We investigate the pricing of 27 important CBs on the Chinese CB market which has 31 CBs together. We get accurate prices using finite difference method. The empirical analysis shows that the theoretical values for the analyzed CBs are on average 2.78% higher than the observed market prices. This mispricing is smaller than previous studies and it indicates that our method is suitable. A partition of the sample according to moneyness indicates that mispricing varies with its moneyness. The mispricing in the mean disappears as convertibles move deeply in-the-money. For deep out-of-the-money CBs, the theoretical values are higher than the observed market prices and the mispricing is large. For at-the-money CBs, they have a slight overpricing. We also find that the mispricing decreases with shorter time to maturity. In this paper, we attempt to give some possible explanation to these phenomena.