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Convertible bond valuation in a jump diffusion setting with stochastic interest rates

Ballotta, L. and Kyriakou, I. (2014). Convertible bond valuation in a jump diffusion setting with stochastic interest rates. Quantitative Finance, doi: 10.1080/14697688.2014.935464

Abstract

This paper proposes an integrated pricing framework for convertible bonds, which comprises firm value evolving as an exponential jump diffusion, correlated stochastic interest rates movements and an efficient numerical pricing scheme. By construction, the proposed stochastic model fits in the framework of affine jump diffusion processes of Duffie et al. [Econometrica, 2000, 68, 1343–1376] with tractable behaviour. We define the firm’s optimal call policy and investigate its impact on the computed convertible bond prices. We illustrate the performance of the numerical scheme and highlight the effects originated by the inclusion of jumps, stochastic interest rates and a non-zero correlation structure between firm value and interest rates.

Publication Type: Article
Additional Information: This is an Accepted Manuscript of an article published in Quantitative Finance on 04/08/2014, available online: http://www.tandfonline.com/10.1080/14697688.2014.935464. Article in press.
Publisher Keywords: Convertible bonds pricing, Stochastic interest rates, Affine jump diffusion model, Optimal call strategy
Subjects: H Social Sciences > HG Finance
Departments: Cass Business School > Finance
URI: http://openaccess.city.ac.uk/id/eprint/3977
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