An Uncertain Volatility Explanation for Delayed Calls of Convertible Bonds

Arbitrage-free price bounds for convertible bonds are obtained assuming a stochastic volatility process for the common stock that lies within a band but makes few other assumptions about volatility dynamics. Equity-linked hazard rates, stochastic interest rates and different assumptions about default and recovery behavior are accommodated within this approach. A non-linear multi-factor reduced-form equity-linked default model leads to a set of non-linear partial differential complementarity equations that are governed by the volatility path. Empirical results focus on call notice period effects, showing that uncertain volatility can capture the call premia so often observed in issuer’s call policies. Increasingly pessimistic values for the issuer’s substitution asset obtain as we introduce more uncertainty during the notice period. Volatility uncertainty is thus a useful mechanism to explain issuers delayed call policies.call notice period, call premium, convertible bond, delayed calls, equity-linked default, stochastic interest rates, volatility uncertainty

An empirical comparison of convertible bond valuation models

This paper empirically compares three convertible bond valuation models. We use an innovative approach where all model parameters are estimated by the Marquardt algorithm using a subsample of convertible bond prices. The model parameters are then used for out-of-sample forecasts of convertible bond prices. The mean absolute deviation is 1.86% for the Ayache-Forsyth-Vetzal model, 1.94% for the Tsiveriotis-Fernandes model, and 3.73% for the Brennan-Schwartz model. For this and other measures of fit, the Ayache-Forsyth-Vetzal and Tsiveriotis-Fernandes models outperform the Brennan-Schwartz model

Determinants of the Issuance of Put/Call Convertibles in the Non-Financial Sector of the US Market

The aim of this article is to characterize and show the differences between issuers of ordinary convertibles and convertibles with attached put/call provisions (put/call convertibles). The research was carried out on a sample of 379 firms in the US market, outside the financial sector, between 2002 and 2011. It turns out that the issuers of put/call convertibles are the companies with a higher risk exposure, associated with, inter alia, a higher level of indebtedness and worse ratio between the issue value to the fixed assets value. Adding the put/call provisions is aimed at decreasing issuers’ risk exposure, which may increase the market demand for this type of convertible securitiesCelem artykułu jest scharakteryzowanie i wykazanie różnic między emitentami zwykłych obligacji zamiennych i obligacji zamiennych z dołączoną opcją put/call. Badanie zostało przeprowadzone na podstawie 379 emitentów tych instrumentów na rynku amerykańskim w latach 2002-2011 spoza sektora finansowego. Okazuje się, że decyzje o emisji put/call convertibles podejmują spółki obarczone wyższym ryzykiem inwestycyjnym, o czym świadczy m.in. wyższy poziom zadłużenia czy gorsza relacja wartości emisji to wartości aktywów trwałych. Dołączenie opcji call/put do zwykłych obligacji zamiennych ma na celu obniżenie ryzyka inwestycyjnego emitenta, co może spowodować zwiększenie popytu na ten rodzaj papierów wartościowych ze strony inwestorów

Convertible debt--a dynamic test of call policy

Includes bibliographical references (p. 26).Supported by MIT International Financial Services Research Center.by Paul Asquith

Why Do Western European Firms Issue Convertibles Instead of Straight Debt or Equity?

Unlike their US counterparts, European convertible debt issuers tend to be large companies with small debt- and equity-related financing costs. Therefore, it is a puzzle why these firms issue convertibles instead of standard financing instruments. This paper examines European convertible debt issuer motivations by estimating a security choice model incorporating convertibles, straight debt, and equity. We find that European convertibles are used as sweetened debt, not as delayed equity. This motivation is also reflected in the highly debt-like design of most European convertible issues. In addition, we show that economy-wide and country-specific factors have a significant incremental impact on the convertible debt choice.Western Europe;Convertible Debt;Security Choice;Security Design

The Importance of Call Delays and Cash Flow Positions in Evaluating the Information Content of Convertible Preferred Stock Calls

We examine a sample of in-the-money convertible preferred stock calls and find that they are delayed. We find that the length of the call delay does not depend on the relation between the preferred stock dividends and the pro rata common dividends to be paid on conversion. Thus, our evidence suggests that preferred stock calls may be used for signaling purposes. In support of this, we find that only delayed calls (i.e., those with potential signaling elements) are viewed negatively by equity investors. We also show that, in responding to delayed call announcements, investors appear to react to two distinct information elements. First, price responses to delayed calls are increasingly negative the larger the cash flow disadvantage to calling. In other words, common investors respond more negatively to calls when the forced conversion results in convertible holders receiving larger dividends than were previously required. Second, both cash flow advantage and cash flow disadvantage firms experience significant downward shifts in earnings growth during post-call periods, suggesting that delayed calls are timely signals of decreasing profitability