Convertible Bond Valuation with Regime Switching

24 Pages Posted: 12 Jun 2020 Last revised: 12 Apr 2021

See all articles by Byung-June Kim

Byung-June Kim

Pohang University of Science and Technology (POSTECH)

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH)

Date Written: May 19, 2020

Abstract

We present a valuation formula for convertible bonds with regime-switching market conditions
by decomposing the convertible bond into a coupon-bearing bond and the American-type
exchange option. A coupon-bearing bond component is modeled with a four-factor model:
a two-factor affine model for the risk-free rate and a two-factor affine model with stochastic
volatility for the credit spreads on the coupon-bearing bond component. We also derive a
new valuation formula for the American-type exchange option component.

Keywords: Option pricing, Convertible bond, Regime switching, Exchange option

JEL Classification: C29, G12, G13, G32

Suggested Citation

Kim, Byung-June and Jang, Bong-Gyu, Convertible Bond Valuation with Regime Switching (May 19, 2020). Available at SSRN: https://ssrn.com/abstract=3604960 or http://dx.doi.org/10.2139/ssrn.3604960

Byung-June Kim (Contact Author)

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

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