Monte Carlo Method Based On Least Squares Analysis, The Deviation Of The Convertible Bond Market Prices

Convertible bonds a complexity finance derivatives. With conversion price, call, put, and so on, pricing convertible bonds is sophisticated. Since Ingersoll(1977)and Brennan & Schwart(z1977)show an innovational approach to pricing convertible bonds, there are more and more papers about pricing convertible bonds. Longstaff & Schwartz (2001) presents a simple yet new approach for approximating the value of American option by using least squares, which opens the door to pricing a series finance derivatives, including convertible bonds.In our article, we get the idea from Longstaff & Schwartz (2001) to value convertible bonds. By Monte Carlo simulation and least squares, we get the convertible bonds model value. At the same condition, compare with Tsiveriotis & Fernandes(1998), we find our model value nearly close to Tsiveriotis & Fernandes(1998)'s results. Secondly, we calculate the model value by static analysis, considering underlying stock price, conversion price, risk-free rate, coupon, maturity, put, call. At last, we investigate the pricing of convertible bonds on 11 convertible bonds of the China's convertible bonds market using daily market closed-price from Jan. 1 2005 to Dem. 31 2007. The empirical analysis shows that, on average, the model values for the analyzed convertible bonds are more 6% higher than market convertible bonds closed prices. In other words, the market prices of convertible bonds are under-priced. Giving trading volume of convertible bonds, invertors, state of China's stock market, and so on, we present why the convertible bonds are under-priced.