China's Securities Market Pricing Convertible Bonds

Convertible bond (take "CB" for short) is a hybrid financial derivative, which possessing many characteristics of both Bond and Stock. In recent years, China CB market develops rapidly. A feasible analytical CB pricing model based on China capital market is urgently needed by investors and the market itself. But domestic theoretical researchers didn't provide a satisfying answer to the problem. There are two main flaws in their researches. One is that domestic researchers often directly apply foreign models to Chinese capital market neglecting its difference to foreign capital markets. The other is that many researchers only select one or two convertible bonds as samples for empirical tests. The empirical results cannot tell generality of the market for its small sample size. Thus, this paper makes attempts to look for an appropriate method for pricing China's CB based on China's CB markets.First, the author reviews the history of CB pricing researches and analyzes representative pricing models' advantages and disadvantages. After that the paper discusses the particularity of China CB market, and tests the influence and sensitivity of several major factors on a typical China CB in a simple binomial tree frame. And then, after thorough comparison of existing famous pricing models based on above analytical results and China CB market's characteristics, the author finds that the model brought forward by Tsiveriotis & Fernandes (1998) is the most appropriate method under the condition of revising certain parameters in the model. At last, the author applies the adjusted pricing model with China's convertible bonds issued in Shanghai and Shenzhen markets to an empirical research on the difference between the model's theoretical value and the observed market price from January to March, 2008. The conclusion is that, from the average price level, the adjusted theoretical model has a good simulation effect on the market price of China's CB, and the theoretical value deviates from the market price about 4%. The study results show that our CB market is rational and there is no obvious universal underestimation or overestimation on the value of CB in China. In addition, the author finds from the empirical results that the market price of CB is too high in its early period during the bond's life compared the theoretical value, and the market price is gradually going back to the rational position since the bond enters into its conversion period.