Pricing Convertible Bonds with Monte Carlo Simulation

33 Pages Posted: 9 Mar 2005

See all articles by Christian Wilde

Christian Wilde

Goethe University Frankfurt - Department of Finance

Axel H. Kind

University of Konstanz

Date Written: March 11, 2005

Abstract

This paper proposes a pricing model that values convertible bonds with Monte Carlo simulation. The optimal exercise boundaries for the embedded American-style conversion, call, and put options are inferred from the conditional expected value of continuation which is obtained by least-squares regressions in combination with a backward-induction procedure. The simulation-based pricing method is more flexible than traditional valuation approaches based on finite differences and binomial trees. It allows to better model the dynamics of the underlying state variables and to account for the specifications of the instrument, such as the path dependencies inherent in many callable convertible bonds. Credit risk is accounted for by directly modelling the possibility of default.

Keywords: Convertible bonds, Monte Carlo simulation, option pricing

JEL Classification: C15, C63, G13

Suggested Citation

Wilde, Christian and Kind, Axel H., Pricing Convertible Bonds with Monte Carlo Simulation (March 11, 2005). Available at SSRN: https://ssrn.com/abstract=676507 or http://dx.doi.org/10.2139/ssrn.676507

Christian Wilde (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

Axel H. Kind

University of Konstanz

Universit├Ątsstra├če 10
Konstanz, D-78457
Germany

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