Research On Pricing Convertible Bonds In China: Based On The LSM Model

Convertible bond (CB) market in China has originated in the early1990s. All along,because of the imperfection of laws®ulations and investors’ lacking of understanding,the development of CB market in China has not been paid sufficient attentions. In the finalanalysis, the reason of leading to this problem is that it’s so difficult to evaluate the valueof CB. Convertible bond is an American option with adding kinds of clauses and thecharacter of path-dependence. Meanwhile, the terms of CB and the interaction of thoseterms also affect its value. The above factors increase the difficulties of pricing CB. Inrecent years, a number of international advanced methods of pricing CB are introduced inChina, which are gradually recognized and accepted by the investors of CB market, buthave some error when being used to price CB of China, because of the complexity of theterms of CB in China.In view of this, the paper uses the game theory to analyze the interaction among theterms of CB. On this basis, this paper also considers the impact of the path dependence ofCB and property of American options to the value of CB. Finally, this paper uses the LeastSquare Monte Carlo Simulation (LSM) model to simulate stock price’s volatility path andconsiders the affection of equity-for-bond rights, redemption rights, resale rights and theright of amending stock price, so as to price CB. This paper tests the efficiency of the LSMmodel about CB pricing, taking example of the sixteen convertible bonds which have beenlisting so far in China market. The empirical results indicate that the LSM model has highaccuracy of pricing the convertible bonds, and the model pricing error is less than5%permissible error range.This paper argues that: the conclusions of LSM model for pricing CB are reliable. Atthe macro level, the rational evaluation of the value of CB using LSM model can inhibitmarket speculation, and boost healthier development of convertible bond market in China.At the micro level, in order to avoid blind investment, investors can take advantage of theLSM model’s results to arbitrage. That is, when the price of CB is undervalued, they canbuy the bonds and sell when overvalued. LSM model’s results can provide reference forissuers of designing the terms of CB.