| Convertible bonds are a kind of bonds which can be converted into ordinary stocks under some conditions,which is essentially a combination of ordinary bonds and call options and usually attached with clauses of redemption,putback and downward revisions of conversion prices.Since the release of the "New Regulations on Refinancing" in 2017,the convertible bond market in China has grown explosively,which raised the importance of researches on convertible bond pricing.Compared with foreign ones,Chinese convertible bonds are more complex in terms of clauses,while issuers’ decision on exercising has an important impact on its pricing.Based on the statistical results of issuers’ exercising decisions in recent years,this paper establishes a decision-making model,which is then incorporated into the traditional LSM pricing model as a boundary condition and results in an extended LSM pricing model and corresponding arbitrage strategies for Chinese convertible bonds.According to our results,there is a big difference between the issuers’ exercising decisions in reality with the assumptions in existing literatures.On the one hand,issuers’ voluntary downward revision of conversion prices is mainly affected by its credit status,and issuers with poor credit status are more motivated to avoid repayment of principal and interest through downward revision of conversion prices.On the other hand,when the listing of convertible bonds has significantly improved the liquidity of underlying stocks or the possibility that the redemption condition is triggered again in the future is relatively high,issuers are more likely to choose not to redeem after the triggering of redemption conditions.Furthermore,the pricing model constructed in this paper show that the convertible bond market in China is not completely efficient.The market prices of some debt-biased convertible bonds are systematically undervalued considering the value of downward revision options,while the market prices of some equity-biased convertible bonds are also significantly lower than theoretical prices considering the possibility of non-redemption.Finally,the arbitrage strategy based on the extended LSM model performs better in getting extra return compared to the traditional model,which indicates its comparative advantage.To conclude,this paper revises the assumptions of issuers’ exercising decisions in existing literatures based on statistical results,and the extended LSM pricing model provides some ideas for investors seeking arbitrage opportunities in the convertible bond market.Meanwhile,our results may affect the issuing and exercising decisions on convertible bonds of listed companies,which will contribute to the improvement of pricing efficiency in Chinese convertible bond market. |
