Pricing convertible bonds based on a multi-stage compound option model

Authors

P. Gong, Huazhong University of Science and Technology, China
Z. He, Huazhong University of Science and Technology, China
Song-Ping Zhu, University of WollongongFollow

RIS ID

15407

Publication Details

This article was originally published as Gong, P, He, Z and Zhu, SP, Pricing convertible bonds based on a multi-stage compound option model, Physica A, 336, 2006, 449-462. Copyright Elsevier. Original journal available here.

Abstract

In this paper, we introduce the concept of multi-stage compound options to the valuation of convertible bonds. Rather than evaluating a nested high-dimensional integral that has arisen from the valuation of multi-stage compound options, we found that adopting the Finite Difference Method (FDM) to solve the Black-Scholes equation for each stage actually resulted in a better numerical efficiency. By comparing our results with those obtained by solving the Black-Scholes equation directly, we can show that the new approach does provide an approximation approach for the valuation of convertible bonds and demonstrate that it offers a great potential for a further extension to CBs with more complex structures such as those with call and/or put provisions.