Calibration and Implementation of Convertible Bond Models

39 Pages Posted: 28 Mar 2003

Date Written: October 27, 2002

Abstract

While convertible bond models recently have come to rest on solid theoretical foundation, issues in model calibration and numerical implementation still remain. This paper highlights and quantifies a number of such issues, demonstrating, among other things, that naïve calibration approaches can lead to highly significant pricing biases. We suggest a number of techniques to resolve such biases. In particular, we demonstrate how applications of the Fokker-Planck PDE allows for efficient joint calibration to debt and option markets, and also discuss volatility smile effects and the derivation of forward PDEs to embed such information into model calibration. Throughout, we rely on modern finite difference techniques, rather than the binomial or trinomial trees that so far have dominated much of the literature.

JEL Classification: G12, G13

Suggested Citation

Andersen, Leif B.G. and Buffum, Dan, Calibration and Implementation of Convertible Bond Models (October 27, 2002). Available at SSRN: https://ssrn.com/abstract=355308 or http://dx.doi.org/10.2139/ssrn.355308

Leif B.G. Andersen (Contact Author)

Bank of America ( email )

One Bryant Park
New York, NY 10036
United States
646-855-1835 (Phone)

Dan Buffum

Bank of America ( email )

100 North Tryon Street, Ste. 220
Charlotte, NC 28255
United States

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