The Effect of Credit Risk on Valuation of Convertible Bond
Date Issued
2008
Date
2008
Author(s)
Shie, Yi-Ping
Abstract
The convertible bond becomes the most important way for the company to raise money, but most of convertible bonds don’t have credit rating. For the investors, the credit risk of convertible bond is elusive. We use the TCRI which is provided by Taiwan Economic Journal (TEJ), Distance to Default (DD) which is calculated by Moody’s KMV model and Z-score which is established by Altman in 1968 as the credit risk measure of convertible bond.e select the 193 convertible bonds issued in 2004 to 2007 as our empirical data and use Least-Square Monte Carlo method to valuate the model price of convertible bond. We verify whether the price differential between model price and issuing price of convertible bond can be explained by credit risk indexes or not. Generally, the greater the credit risk, the higher the price differential of convertible bond. The greater TCRI rank indicates the higher credit risk; the greater DD and Z-score indicates the lower credit risk. In other words, the relation between TCRI and price differential is positive; the relations between DD and price differential, Z-score and price differential are both negative. The results show that 9.7% of the price differential can be explained by credit risk indexes, and the explanatory power of TCRI is the strongest. The entire explanatory power is not high. It implies that there are still some parts of price differential can not be explained. These parts may be explained by liquidity, corporate governance and conversion stock is diluted which are left for future research.
Subjects
Convertible Bond
Least-Square Monte Carlo
Credit risk
Distance to Default (DD)
Z-score
Type
thesis
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