Analysis On Relations Between Convertible Bond And Underlying Stock

Convertible bond is to mean the investor can convert it to stock in certain time according to the legal procedure issue. On the one hand convertible bond is fixed income security, the investor can acquire fixed interest income annually; On the other hand the investor has a right to convert it to stock according to the engagement. So the investor can share the growth of corporation value, meanwhile they can get the debt revenue when the stock price falls.The stock price can influence the convertible bond's option value and exchange value; Convertible bond's issue, turning to stock and redeeming can influence the stock price. But the connection which is strong or weak is subjected to the efficiency in capital market and the equity nature of convertible bond. If the capital market is valid, the arbitrage activity will make the connections between them close; If convertible bond tend to convert to underlying stock, theirs price has strong connection, otherwise the connection is weak.This paper aims at investigating the interaction among three indexes: convertible bond index, convertible bond parity index and underlying stock index. By applying the Granger causality test, co-integration test, impulse response function analysis and variance decomposition analysis to them, the empirical results suggest: There existed a long term equilibrium relation among three indexes: the convertible bond price is the Granger cause to underlying stocks price, but the underlying stock price is not the Granger cause to convertible bond price. Obviously the three indexes are connected closely. Furthermore we can get a result that the convertible bond market and the underlying stock market is connected closely.The reactions between the two markets impact the investment in convertible bond strongly. The investor who directly hold convertible bond can do investment decision according to the stock price; the investor constructing portfolio can add convertible bond in, and the valid frontier of portfolio will expand .The arbitrageurs and hedgers can use it obtaining the fixed revenue.