Valuation of Convertible Bonds with Default Risk
Date Issued
2009
Date
2009
Author(s)
Wang, Hsin-Yin
Abstract
This paper presents the valuation of convertible bonds by using stock price, short rate, and default risk. We used binomial (CRR) Model to construct binomial stock price tree; while short rate was transformed into two binomial trees by using Ho-Lee Model and Black-Derman-Toy (BDT) Model. Two different equations were obtained while analyzing default risk by Chambers-Lu Model and by Hung-Wang Model. By investigate these two equations, we demonstrated if the longer the duration, the smaller the price of default-free bonds. Then, default probabilities obtained by Chambers-Lu Model tend to be greater than the probabilities obtained by Hung-Wang Model.fter using stock price, short rate, and default risk to construct hexnomial tree and calculate risk-neutral probabilities, we concluded that the model is incomplete since these prices were not unique. Convertible bond price intervals were calculated using by risk-neutral probabilities. We observed that the probabilities used in the paper introduced by Hung and Wang were not risk-neutral probabilities. Moreover, we compared and discussed the convergence convertible bond price intervals as the number of periods→∞.
Subjects
Convertible Bond
Binomial (CRR) Model
Black-Derman-Toy (BDT) Model
Ho-Lee Model
Default Risk
Chambers-Lu Model
Hung-Wang Model
Type
thesis
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