Pricing Of Convertible Bond Based On LSM Model And Investment Strategy

An important issue with convertible bonds is that they are difficult to value. This is due to the fact that the exercise of the conversion right requires the bond to be redeemed in order to acquire the shares. For this reason, a conversion right is, in fact, a call option with a stochastic exercise price. In addition, most convertible bonds are callable in practice.This means that the issuing firm has the right to pay a specific amount, the call price, to redeem the bond before the maturity date. Often, the call notice period is combined with a soft call feature where the bond can only be called if the underlying stock price stays above a certain pre-specified level for a pre-specified period. The convertible bond is puttable and embedded in the downward reversion clause All these features complicate the valuation process for convertible bonds.Taking into account the characteristics of the American option and the path dependence of the embedded option in the convertible bond, in this paper, we use the LSM model to solve the path dependence problem to simulate the price path of the underlying stock, which can be converted into the pricing of convertible bonds.We use the GARCH model to measure the volatility of stock. Eleven of the 19 convertible bonds we choose, which were listed on the market in 2013,2014 and 2015, do not conform to the GARCH model. So this article uses the remaining eight to test the validity of the pricing model. On the whole, the convertible listed on the market are overvalued. In view of this, this article can formulate the corresponding investment strategy. Investers can buy the corresponding bonds when they are undervalued and sell the corresponding bonds when the degree of deviation between the theoretical value of the model and the market price to achieve a certain threshold.