Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/199116 
Authors: 
Year of Publication: 
2013
Citation: 
[Journal:] Journal of Derivatives & Hedge Funds [ISSN:] 1753-965X [Volume:] 19 [Issue:] 4 [Publisher:] Palgrave Macmillan [Place:] London [Year:] 2013 [Pages:] 259-277
Publisher: 
Palgrave Macmillan, London
Abstract: 
This paper presents a new model for valuing hybrid defaultable financial instruments, such as, convertible bonds. In contrast to previous studies, the model relies on the probability distribution of a default jump rather than the default jump itself, as the default jump is usually inaccessible. As such, the model can back out the market prices of convertible bonds. A prevailing belief in the market is that convertible arbitrage is mainly due to convertible underpricing. Empirically, however, we do not find evidence supporting the underpricing hypothesis. Instead, we find that convertibles have relatively large positive gammas. As a typical convertible arbitrage strategy employs delta-neutral hedging, a large positive gamma can make the portfolio highly profitable, especially for a large movement in the underlying stock price.
Subjects: 
hybrid financial instrument
convertible bond
convertible underpricing
convertible arbitrage
default time approach
default probability approach
jump diffusion
Published Version’s DOI: 
Document Type: 
Article
Document Version: 
Accepted Manuscript (Postprint)
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