Convertible Bond Underpricing: Renegotiable Covenants, Seasoning and Convergence

46 Pages Posted: 28 Mar 2005  

Alex Chan

The University of Hong Kong, School of Economics and Finance

Nai-fu Chen

University of California, Irvine - Finance Area

Date Written: March 3, 2005

Abstract

We investigate the long-standing puzzle on the underpricings of convertible bonds. We hypothesize that the observed underpricing is induced by the possibility that a convertible bond might renegotiate on some of its covenants, e.g., an imbedded put option, in financial difficulties. Consistent with our hypothesis, we find that the initial underpricing is larger for lower rated bonds. The underpricing worsens if the issuer experiences subsequent financial difficulties. However, conditional on no rating downgrades, our main empirical result shows that convertible bond prices do converge to their theoretical prices within two years. This seasoning period is shorter for higher rated convertible bonds.

Keywords: Convertible bond, credit risk, valuation

JEL Classification: G12, G13, G14

Suggested Citation

Chan, Alex and Chen, Nai-fu, Convertible Bond Underpricing: Renegotiable Covenants, Seasoning and Convergence (March 3, 2005). Available at SSRN: https://ssrn.com/abstract=678101 or http://dx.doi.org/10.2139/ssrn.678101

Wing-Ho Alex Chan (Contact Author)

The University of Hong Kong, School of Economics and Finance ( email )

Pokfulam Road
Hong Kong
Hong Kong

Nai-Fu Chen

University of California, Irvine - Finance Area ( email )

Irvine, CA 92697-3125
United States

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