Economics and Finance

    

Convertible Bond and Credit Risk

Authors: David Lee

Convertible bond is issued mainly by start-up or small companies. It is susceptible to credit risk. This paper presents a model for valuing convertible bonds by taking credit risk into account. Testing results show that model prices fluctuate randomly around market prices, indicating the model is quite accurate. Convertible bond arbitrage usually employs delta-neutral hedging where an arbitrageur buys a convertible bond and sells the underlying equity at the current delta. Delta neutral hedging removes small directional risks and makes a profit on an explosive upside or downside breakout if the position’s gamma is kept positive. Thus, delta neutral hedging is great for uncertain stocks that are expected to make large breakouts in either direction.

Comments: 23 Pages.

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Submission history

[v1] 2022-03-29 17:47:32

Unique-IP document downloads: 436 times

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