Convertible Bonds Valuation in a Jump Diffusion Setting with Stochastic Interest Rates
Quantitative Finance, 2015, 15(1), 115-129
23 Pages Posted: 4 Jul 2009 Last revised: 9 Feb 2019
Date Written: August 12, 2014
Abstract
This paper proposes an integrated pricing framework for convertible bonds, which comprises firm value evolving as an exponential jump diffusion, correlated stochastic interest rates movements and an efficient numerical pricing scheme. By construction, the proposed stochastic model fits in the framework of affine jump diffusion processes of Duffie, Pan and Singleton [Duffie, D., Pan, J. and Singleton, K., Transform analysis and asset pricing for affine jump-diffusions. Econometrica, 2000, 68, 1343-1376] with tractable behaviour. We define the firm's optimal call policy and investigate its impact on the computed convertible bond prices. We illustrate the performance of the numerical scheme and highlight the effects originated by the inclusion of jumps, stochastic interest rates and a non-zero correlation structure between firm value and interest rates.
Keywords: Convertible bonds pricing, Stochastic interest rates, Affine jump diffusion model, Optimal call strategy
JEL Classification: G12, G13, C63
Suggested Citation: Suggested Citation